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The stock market seems stuck in “up” mode lately. The S&P 500 just capped off a seventh straight month of gains, notching daily declines only six times in August and setting 53 new all-time highs so far this year. That is a blistering pace of a new record set nearly every third trading day.
Through August, the S&P 500 has surged more than 20% year to date—about double its long-term historical average. Investors have continued to brush off any bigger threat to the economy from a surge in the number of Covid-19 delta variant cases and barely reacted after Federal Reserve Chair Jerome Powell indicated the central bank is likely to begin tapering its $120 billion in monthly bond purchases by year end.
There’s reason to expect more gains ahead: Just look at how much the economy has already healed, notes Matt Stucky, senior portfolio manager at Northwestern Mutual. For instance, the labor market has recovered about 75% of the jobs lost in mid-2020.
“We’re optimistic that even with the gains in the market this year, we can still move higher from here,” he says.
And yet, September also brings a case for caution: The stock market is heading into what’s historically been its weakest month of the year, and investors may shift up some positions ahead of the third quarter earnings season that kicks off in October, says Keith Buchanan, senior portfolio manager at GLOBALT Investments.
“This is a period that, as a firm, we’re cautious about,” he says.
Whether the market can notch an eighth straight month of gains will depend largely on the Fed’s communication about its plans and any change in momentum in the economic recovery. Here’s what investors will be watching.
The Fed’s Policy Hasn’t Changed—Yet
In a speech at the Jackson Hole economic policy symposium in late August, Powell reiterated the central bank’s commitment to easy money. While Covid-related uncertainty remains, Powell indicated that the central bank could begin buying fewer bonds, what’s known as tapering, by the end of the year.
Following the global financial crisis, the Fed’s decision to begin tapering bond purchases set off turmoil in markets in an event termed the taper tantrum. This time around, policymakers will try to stave off a similar reaction, Buchanan says, making communication “critical in order to not surprise the market.” Investors will get another opportunity to hear from the Fed relatively soon as the central bank has a regularly scheduled meeting planned for Sept. 21 and 22.
Even prior to the Fed’s Jackson Hole conference, though, market participants were signaling they were preparing for the possibility of tapering to come, Buchanan notes. That’s best reflected by a slow rise in the yield on the benchmark U.S. Treasury note over the course of August.
Regardless of when tapering formally begins, the prospect of higher rates is still a long way off.
“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” Powell said in his Jackson Hole speech.
Meanwhile, inflation continues to rise, though the Fed still maintains that the causes are mostly temporary in nature—an idea that Northwestern Mutual agrees with, Stucky says. Nevertheless, any signs of a long-lasting, acute rise in prices will be important to monitor because sticker shock in some markets, like housing, could have a broader economic impact, he adds.
Luckily, the economy has healed significantly since last year, which puts markets in a better position to weather an eventual shift in Fed policy, Stucky says.
“The Fed tapering asset purchases is probably not going to have the type of dislodging effect as it would if this were a different type of economic recovery,” he notes.
Could Covid Slow Momentum?
The jobs report scheduled for release on Sept. 3 will reflect a full month of any potential impact from the delta variant on the pace of economic growth, Buchanan says.
This information will come at a key time, ahead of the third-quarter earnings season that begins in October. As of mid-August, analysts on Wall Street were projecting that companies in the S&P 500 will report earnings growth of nearly 28% from the year before, according to figures compiled by FactSet.
Whether that growth level remains feasible going into the last quarter of 2021, though, may depend on how surprising the most recent jobs data is. But already other economic indicators are projecting future economic gains may be more conservative.
Two Federal Reserve forecasting models of the pace of gross domestic product (GDP) growth—one from the New York Federal Reserve and the other from the Atlanta Fed—are pointing to more moderate gains in the third quarter than prior estimates. And consumers have been signaling more uncertainty about the overall state of the economy in recent weeks, with dissent showing up between age groups, according to the Forbes Advisor-Ipsos U.S. Consumer Confidence Weekly Tracker.
How the rise in delta variant cases continues to play out in the coming weeks will be key to the market’s performance—and the economy more broadly—heading into the end of the year, Stucky notes. That’s led to a bit more anxiety in the market, though “there are some good signs that maybe the worst is behind us,” he adds.
How to Invest in September
September is historically the weakest month of the year, with the S&P 500 posting average declines of 1% during the month going back to 1928, according to Yardeni Research. Expect some volatility, or at the least some shift in asset allocation between growth and value stocks as professional investors try to predict the Fed’s next steps and what corporations will forecast about 2022 during earnings season, Buchanan says.
Volatility has been pretty average recently, so the eventual return of bigger daily swings up or down—be it in September or later—are likely to feel more pronounced, Stucky notes.
“Compared with what we went through, it will feel higher, but it’s not all that different from history,” he says.
The trifecta of Covid, inflation and Fed policy—which have been the dominant themes in the market for months—are likely to continue, Stucky says. That’s seen investors fly to quality assets like large-cap growth stocks and Treasuries, though the market’s laggards do have room to catch up, he adds.
With so much uncertainty about Covid, in particular, a diversified portfolio with a mix of various stocks is the best approach.
“That’s what we’ve been preaching to clients,” Stucky says.