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- September is the worst month for stocks, and right now the market rally looks weak.
- Evercore's Julian Emanuel say investors should play defense until a buying opportunity in October.
- He breaks down the three signs a recession might lie ahead, including a key employment figure.
"Sell in May and go away" is a timeless stock market adage, describing the market's penchant for dropping as summer begins and investors turn their attention away from bar charts and to the beach.
But while markets sell off in the month of May, it's got nothing on September.
Historically speaking, September is the worst month for stocks by a mile.
This may be a particularly stormy September, as mounting fears across the market give investors pause, forcing them to wonder if this year's rally may finally run out of steam.
Julian Emanuel, a senior managing director at Evercore ISI, recently published a note for clients warning them of what may be ahead. He detailed what investors should be wary of heading into September, where they should be investing, and why a bad September for stocks may be a blessing in disguise.
3 warnings signs that a recession lies ahead
The once-roaring stock market rally has stalled out since the S&P 500 hit a high at the end of July as investor optimism begins to fade.
A simple indication of this: earlier this year the market was dragged higher as Nvidia announced stellar first-quarter earnings that pointed to a bright future for AI in general, and tech stocks in particular.
Somehow Nvidia topped that performance with its second-quarter earnings announcement. But instead of celebration and buying, investors greeted the news with a shrug and a sell-off.
Perhaps this sell-off is a natural part of summer turning to fall, and investors simply wanted to take their winnings and run.
But is the recent market weakness really just due to seasonality?
Emanuel doesn't think so. He believes the market has reconstructed the 'Wall of Worry' that it had seemingly demolished back in July, when fears of a recession gave way to optimism.
"The "Wall of Worry" that had all but disappeared by July is being rebuilt – U.S. 10 year yields above 4%, anxiety rising in China, Europe's economy slumps, and a more sober tone from some U.S. retailers," Emanuel wrote.
Emanuel is particularly concerned about bond yields — specifically 10-year yields, which, historically, have a habit of hurting markets any time they rise above 4%, as they did in late 2022 and early 2023.
Emanuel noted that stocks and bonds spent 2022 and the first quarter of 2023 positively correlated, with stocks heading down and yields rising as inflation volatility kept investors jumpy.
But that all changed in March as the banking crisis hit, and investors were suddenly willing to take on risk again, buying into the stock market's sudden surge and sending stocks higher. Yet bond yields rose as well even as investors bought into a "risk on" mentality, Emanuel wrote.
"'Risk On' returned as the combination of AI leaders' gains rekindling animal spirits, the knowledge that the Fed 'has depositors' backs' and raising the debt ceiling to fund spending further toward infinity is 'business as usual,'" he wrote.
But if that risk-on attitude changes to risk off, Emanuel believes that's the first warning sign that markets are in trouble and a recession may be imminent.
"While stocks have indeed become 'queasy' with yields continuing to grind higher during August, the bigger risk would be if the 'paradigm flipped' to 'Risk Off' and both stocks and yields started to move lower, as they did during prior periods of 'Risk On/Risk Off' within the previous Positive Correlation epoch – 1998, 1987, 1974, all Bear Market years," Emanuel wrote.
There are two other warning signs Emanuel is keeping an eye on. First, he's been pleased with the strength of the US industrials sector, which has weathered the weakness in Europe and China well.
However, if the industrials sector falls below its 200-day moving average, it's a sign that this key sector has capitulated, and could indicate that the rest of the economy will fall with it.
Finally, Emanuel believes that the most important indicator of the economy's health is jobs. Initial jobless claims in particular are the "gold standard" of jobs data, and the August 31 report will be a key data point for determining what's ahead for the US economy, he wrote.
While jobless claims have trended higher recently, Emanuel wrote that a warning sign will be if they rise to over 250,000 per week, and a glaring indication that a recession has arrived will be if jobless claims spend four or more weeks above 300,000.
'August top, September drop, October buy'
While a difficult September in the face of all the aforementioned worries above may seem like an investor's nightmare, historically speaking, it's actually a good thing.
With a sell-off in September, October can present investors with an opportunity to buy at a lower price point. And in the years that a September sell-off doesn't occur, as was the case in 2018 and 2007, the market has a habit of making investors pay for it.
With all that said, how should investors take advantage of the buying opportunity after the September doldrums fade away?
Emanuel wrote that he remains bullish on energy and healthcare stocks right now. He's also investing in tangentially AI-related companies, including Vertiv Holdings (VRT), JPMorgan (JPM), Booking Holdings (BKNG), and Domino's Pizza (DPZ), when opportunities present themselves to buy in cheaply.
"We also want to continue owning Zero Cost Collar Option hedges on growth centric, rate sensitive QQQ," Emanuel wrote.
Emanuel concluded his message to investors by succinctly summarizing how best to handle a market downturn in September.
"Stay defensive into October, the high conviction buying opportunity still lies ahead, at lower prices."
3 Warning Signs of Recession, and How to Invest in September: Evercore - Business Insider
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