Time to Brace Yourself for a Labor Day Stock Market Sell-Off?

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Labor Day is coming up. On September 2, the North American key stock indices will be closed for business—no trading will take place. Not only will it mark the end of summer, but it will also be the last long weekend before the Thanksgiving weekend in November. 

That said, one question comes to mind: why does Labor Day matter to investors; what’s so important? 

First off, during the summer months, the volume on the key stock indices is usually low. This means participation isn’t as high, so major market moves usually don’t occur. In September, the volume then starts to edge higher. Those who were away for vacation  come back to their trading desks and start buying or selling—in other words, they start adjusting their portfolio. 

Keep in mind that the majority of the crashes we have seen in key stock indices occurred during the time between September and November. This includes, Black Monday (October 19, 1987) and the crash after Lehman Brothers failed and filed for bankruptcy (September 15, 2008). 

Further, the key stock indices have accumulated some risks that investors shouldn’t forget, as they have increased significantly. Look at the chart below of the S&P 500:

Chart courtesy of www.StockCharts.com 

Since the first trading day of the year, the S&P 500 has increased roughly 16%; other key stock indices have shown a similar performance. You have to keep in mind that this rise in the key stock indices was based on very weak growth in the U.S. economy—the gross domestic product (GDP) growth rate for the U.S. is anemic. In addition, the unemployment situation remains bleak. 

On top of this, going forward, for the third quarter of 2013, 75 companies on the S&P 500 have provided negative guidance about their corporate earnings, while only 17 have provided positive guidance. (Source: “Q2 2013 S&P 500 earnings round-up,” FactSet, August 16, 2013.) 

Lastly is an even bigger issue, which is the tapering of quantitative easing by the Federal Reserve. 

Since late last year, the Federal Reserve has been printing $85.0 billion a month; $40.0 billion is going towards buying mortgage-backed securities (MBS) and $45.0 billion is going towards purchasing long-term government bonds. This phenomenon has caused the key stock indices to increase. 

Now the Federal Reserve is talking about reducing the size of its purchases; therefore, the key stock indices may be affected. We have seen in the recent past that whenever there were talks about tapering off the Fed’s quantitative easing, the key stock indices headed lower. Look again at the chart above to see what happened to the S&P 500 after May 22, and then when there was more speculation—it declined in early August once again. 

My colleague, John Whitefoot, wrote a good article on this topic. You can read it here. 

Investors shouldn’t forget to manage their risk going forward. The light, dwindling volume may have caused key stock indices to rise beyond reality. When they come back, and the risks being faced are now stacked higher, it may not be a pretty picture. Time will tell us more, but until then, be careful.

~by Mohammad Zulfiqar, BA 

This article was originally published at DailyGainsLetter.


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