ETF Volatility Likely To Continue In September

After the month of August unleashed bearish forces and gave investors wild rides on both sides of the unchanged line, we are now facing September, which historically has been the worst performing month for the equity markets.

MarketWatch had some thoughts on what’s coming up in “Looking at a scary September:”

This September is likely to be particularly volatile as Federal Reserve Chairman Ben Bernanke deferred any new simulative action until the now two-day Fed meeting on Sept. 20 and 21.

Also, International Monetary Fund leader Christine Lagarde said the global economy was in a dangerous phase while Kansas City Fed President Thomas Hoenig, said last week that the Fed, “can’t do it all,” adding further to the uncertainty facing us as we leave the dog days of summer behind.

Beyond the gloom from the Tetons, a continuing stream of economic reports indicates that the economy continues to slow towards “stall speed.” Manufacturing has dropped to contraction levels and the revision to second-quarter GDP to 1% brought the economy perilously close to negative growth.

Seasonality also points to a rocky ride ahead as Septembers are historically the worst performing month for the stock market. Since 1928, September has recorded more down months than any other month and also holds the record for the worst monthly drop in history which came in September, 1931, when the Dow lost -30%. Septembers can be an “up” month, but the percentage of positive Septembers is the lowest of any month on the calendar.

Beyond September, of course, comes the notorious month of October which is known for major stock market crashes including Black Monday on Oct. 19, 1987, and Black Monday on Oct. 28, 1929. Based on historical performance for September and October, it’s easy to conclude that the next couple of months could be a wild ride, indeed.

With troubling seasonal factors, negative economic reports and a schizophrenically volatile stock market, it’s no wonder that little guys like us feel dazed and confused.

As we head into the dangerous weeks ahead, here are two options to consider:

1. Sometimes the best position is no position. As I wrote in The Guru’s Corner on MarketWatch in October, 2008, when markets enter a “cone of confusion,” sometimes the best policy is just to stand aside until the fog clears. Today’s market and economy would certainly qualify as such a cone of confusion. In more and more ways, today’s conditions are starting to remind me of the “bad old days” and so cash could be a good place to be until the fog clears.

2. Head for safety. In spite of the recent credit downgrade of the United States, safe U.S. Treasuries are still considered a “safe haven,” and iShares Barclays 7-10 Year Treasury Bond Fund IEF +0.34%  has been on a major tear.

All in all, it looks like a precarious period ahead, and, as the old saying goes, sometimes the “best offense is a good defense.” In my opinion, caution would seem to be the most prudent course to steer as we say goodbye to Jackson Hole and head into the potential shoals of September.

It’s highly unusual for main stream media to offer the idea of being on the sidelines and in cash. Maybe there is hope after all that someone eventually mentions the use of trailing sell stops as a means to get to the cash position.

I wholeheartedly agree with what has been said above, and even the idea of heading for the safety of treasuries is a sound one at this particular point in time.

Still, my preference is not to guess as to what September will bring us in terms of market direction. I will rely on actual trends to make investment decisions as difficult as they may seem at times.

Case in point is our Domestic TTI (Trend Tracking Index), which signaled a ‘Sell’ effective on 8/9/11. Ever since that date, it has been bouncing above and below the trend line with no clear direction, but lately it has been staying modestly above it as the markets recovered during the last seven trading days of August.

The main reason for not issuing an immediate ‘Buy’ after the TTI crossed the trend line to the upside is the possibility of a sudden reversal causing a whip-saw signal. While I prefer to make strictly unemotional Buy/Sell decisions, market behavior does not always allow this luxury all the time. This holds especially true during major inflections points when the TTIs cross their trend lines, but do not follow through to establish a clear new direction.

This is the moment in time, where you have to apply some subjective reasoning to get through that temporary period of uncertainty. Sooner or later, however, the real trend will become obvious and allow us to proceed as planned.

Since anything is possible in September, as the article above pointed out, we’re still in ‘Sell’ mode domestically, despite the TTI flirting with the bullish side of the trend line. Additionally, we’re still holding our PRPFX hedge, with which we were, for a while, stuck in no man’s land.

After Labor Day, I believe a major trend will re-emerge and will allows us to either keep the hedge, if markets move south, or liquidate the short position and issue a new domestic ‘Buy’ should the momentum carry us further north.

Again, the idea here is to acknowledge that you can get stuck once in a while, as I have demonstrated over the past couple of weeks, but you need to have a plan to unwind these positions to again align with the major trend, as soon as it can be identified.