Why August Might Flip In Favor of the Bulls

If the Fed holds rates steady, it could give bulls the morale boost they need to send stocks higher in August

by Bernie Schaeffer

Published on Jul 31, 2018 at 8:27 AM

The following is a reprint of the market commentary from the August 2018 edition of The Option Advisor, published on July 27. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

As we wrap up the month of July, the S&P 500 Index (SPX) and SPDR S&P 500 ETF (SPY) have pushed back above the 2,800 and 280 levels, respectively, which had acted as technical resistance since early February. Notably, this "super round-number" level on the S&P also corresponds with a market value of $25 trillion for the benchmark index. While this breakout is encouraging from a chart perspective, this puts the broad-market trackers on pace for an imminent re-test of their late-January all-time highs, which are now just a chip shot away from current levels.

Given that the last S&P excursion up to those early 2018 highs was quickly followed by a roughly 12% peak-to-trough correction in SPY over the course of just two weeks, the currently wary attitude among investors is understandable. In the American Association of Individual Investors (AAII) survey for the week ended July 25, the percentage of respondents who said they were "neutral" on stocks vaulted to a two-month high of 41.6%.

This apparent "paralysis" in investor sentiment is no doubt exacerbated by the daily barrage of headlines about tariffs, Iran, and the various other macro-level chess pieces currently in play. And beyond that, many traders are likely aware that we're entering a somewhat more challenging seasonal period for the stock market.

Looking back at historical monthly returns since SPY's inception in 1993, Schaeffer's Quantitative Analyst Chris Prybal reports that August and September are two out of just three months in the year when the broad-based exchange-traded fund (ETF) averages a loss. The third calendar month where SPY has yielded a negative average return is June -- but this past June, the S&P tracker eked out a narrowly positive monthly return, closing up all of 0.1% from May's month-end price.

Unlike June, with its 46% positive returns, the historically negative average SPY returns in August and September appear to be driven primarily by outsized losses relative to gains. For example, while SPY has been positive 64% of the time in August, the average negative return of -5.09% is more than double the average positive return of 2.20%.

spy avg monthly returns since inception

In light of June's seasonality-defying SPY performance, it's worth a fresh look at how August and September tend to shape up for stocks following a positive June. The below table, courtesy of Schaeffer's Senior Quantitative Analyst Rocky White, reveals that August tends to be net flat after a positive June, with the average return amounting to a decline of just -0.16% (with the median return at 0.45%).

As with the complete data set since 1993, the lackluster performance in August following a June SPY gain is driven by extremely heavy declines relative to advances, given that the returns are 73% positive. The average positive August return of 2.25% is nearly identical to the since-inception average positive return of 2.20% for this month, but note in the table below that the average negative August return widens to -6.61% after a positive June.

September, meanwhile, flips into the "win" column after a June gain for SPY, up 1.06% on average. The drilldown here is fairly unremarkable; with 64% positive, the average positive return is 3.32%, and the average negative return is -2.89%.

 

spy returns when june is positive

And while it may seem from the table above that the month of August could essentially be a "wild card" after the market's photo-finish gain in June, White's data shows that the more recent trend is for a positive August to follow a positive June. Specifically, in the last six years where SPY has closed higher in June -- going back to 2000 -- the ETF has also gone on to close higher in August.

spy august returns when june is positive

This time around, the Fed could actually bolster the case for another August rally. In the current rate-tightening cycle, stocks have consistently been flat-to-lower in the month following a Fed rate hike, with rallies ensuing after meetings where the policy-setting group stands pat -- a phenomenon regularly tracked and reported on by Schaeffer's Senior V.P. of Research Todd Salamone in his weekly Monday Morning Outlook column. With no hike expected to result from the upcoming July 31-Aug. 1 Federal Open Market Committee (FOMC) meeting, it looks as though investors may get the "morale boost" they need just in time to tip the scales in favor of another bullish August.

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