What is it about September?

September has historically been the worst month for stocks, according to St. Louis Federal Reserve data measuring monthly S&P 500 performance over the last 50 years. If you are wondering whether the trend has abated in recent years, the answer is no, it hasn’t. Over the last 10 years, September performance has been substandard. While analysts have offered various explanations, no one has pinpointed the reason we sometimes see seasonal weakness as summer concludes. 

September 2021 was the first monthly decline since January and the worst decline since March 2020 when the lockdowns began. So, what’s behind the sell-off last month? 

The economy is not contracting, and a moderation was expected after Q2’s 6.7% annualized growth rate (U.S. BEA), but the slowdown has been more pronounced than expected. 

The Atlanta Fed’s GDPNow model, which incorporates economic data that impacts GDP, suggests that Q3 growth is tracking at just 2.3%. This would include Q3 data released through October 1. That means all of July, most of August and none of October’s data have been inputted into the model.

While profit growth has soared coming out of the lockdowns, a more pronounced moderation in profit growth may be on tap.

Next question, why is Q3 disappointing on the economic front? Well, the spike in Covid cases is causing some hesitation in industries that are dependent on face-to-face transactions. But there is good news on this front. The CDC says cases have slowed recently to a 7-day average of 84,555 as of October 15th, which is down from its recent high at the beginning of September when the 7-day average was about 160,000. We’ll see how this continues to play out later in the fall. 

While bank deposit data from the St. Louis Federal Reserve suggest consumers have plenty of spendable cash in reserve, the influx of new stimulus money has dwindled, and spending has slowed. We’re also seeing stubbornly high inflation in some industries, as supply chain bottlenecks aren’t fixing themselves.

If you have a Wall Street Journal account, consider the title of this story from late August: Why Is the Supply Chain Still So Snarled? We Explain, With a Hot Tub. Utah manufacturer Bullfrog Spas depends on a complicated network to bring materials from across continents and oceans. The pandemic put it out of whack. https://www.wsj.com/articles/why-is-the-supply-chain-still-so-snarled-we-explain-with-a-hot-tub-11629987531

This article about sums up the problem for many manufacturers.

As Fed Chief Jerome Powell noted at the end of September,  bottlenecks and shortages of key raw materials are “not getting better—in fact at the margins (they are) apparently getting a little bit worse.”

Like severe labor shortages, supply chain problems are crimping profitability, limiting sales, raising prices and hampering economic growth. Investors are taking note.

An uptick in bond yields near the end of the month also dampened sentiment. While yields remain quite low, they ticked higher after the Federal Reserve (the Fed) took on a slightly more hawkish tone at the September meeting.

The Fed has been transparent about its plans to begin tapering its bond purchasing program.  Currently, the Fed is buying an additional $120 billion in U.S. government bonds each month.  Many analysts anticipate they will reduce the bond buying by $15 billion per month until they are no longer buying additional bonds, and then the Fed would only re-purchase bonds once they matured.

Transparency has been very important to the Fed, as they don’t want to cause a repeat of the 2013 “Taper Tantrum” that shocked the markets.  There could still be some volatility in the markets, but with anticipation of the Fed’s actions, many analysts think tapering has been baked into market expectations.

If the Fed begins its tapering process, in theory, yields should increase as demand for those bonds need to be absorbed by the market.  If interest rates rise, that usually pushes bond prices down, but it also makes bonds more competitive to stocks.  Economists and analysts are not anticipating the Fed to raise interest rates until the end of 2022 or even 2023.  Even then the rates may only increase by .25% per hike.

These are probably the biggest reasons for the pullback last month. Not to be Debbie Downer, but let’s look at a few more.

The debate over the debt ceiling isn’t over. The U.S. Treasury has said it will run up against the current debt ceiling on October 18.  Congress passed a short-term extension, which pushes the deadline to December 2021.  If the U.S. were to hit the debt ceiling, it means it can no longer borrow to fund operations, and the U.S. would default on its debt unless Congress finds a longer-term solution to extend the debt ceiling.

As Moody’s Analytics recently noted, “The debt ceiling will be raised. Not doing so would be catastrophic for the economy, so this is an extremely low probability event.”

We’ve seen this drama play out before (under the previous administration, the debt ceiling was raised 3 times), and lawmakers avoided sailing into uncharted waters. Still, it’s causing some headline anxiety.

China’s largest and most indebted property developer (Evergrande) is on the brink of bankruptcy. While Western financial exposure is likely limited, a disorderly default could create

big problems for the world’s second-largest economy.

Finally, an energy crisis is brewing in Europe, while natural gas prices hit new highs in Asia. They are running about six times what we see at home (Reuters).

But that doesn’t mean we won’t be affected.  Nearly half of U.S. households heat their homes with natural gas, and they could experience higher energy bills this winter.  These costs may get added to manufactured goods and/ or restrict output, adding to supply chain woes.  

Rising energy prices are another example of how inflation has been affecting the global economy as it tries to get back to life before the pandemic.

What this means for our portfolios

For this quarterly rebalance, we are making a series of small tweaks to the portfolio.  We are limiting some of the bond purchases, as changes in monetary policy could lead to some short-term volatility.  We are also limiting our selling of investments we think will continue to perform well in a higher than normal inflationary environment and mid business cycle economy like U.S. mid cap stocks, real estate, and commodities.

We plan to add to international and emerging market equities as they appear to be undervalued when compared to domestic stocks.  The Fed’s monetary policy could cause the the dollar to weaken against international currencies, which can potentially provide a tailwind for foreign investments. As these international countries get larger portions of their populations vaccinated and COVID has less economic impact, there could be potential for strong growth as they rally to their pre-pandemic levels.

Final thoughts

For all but the most aggressive and risk tolerant investors, we recommend a healthy portion of fixed income investments. Adding a mix of bonds into the portfolio can potentially smooth returns. We may not see the extreme highs when stocks are rising but mixing in lower volatility assets like bonds reduces the risk on the downside when equities turn lower.

As we’ve noted in the past, stocks tend to take the stairs up and the elevator down. If we are headed toward an overdue correction, pullbacks tend to be short lived.

We trust you’ve found this review to be educational and informative.  

Let us emphasize that it is our job to assist you. If you have any questions or would like to discuss any matters, please feel free to give us a call. 


This research report has been prepared by the Centerline Wealth Advisors Investment Committee 2021©


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