Since spiking earlier this summer, market volatility is now back to spring lows.This is partly because mixed economic reports – including last week’s second-quarter gross domestic product and July non-farm payroll data – continue to suggest that the US economy is grudgingly improving.The modest pace of the recovery, coupled with historically low inflation, suggests that the Fed has the latitude it requires for a gentle exit. As a result, stocks have been eking out gains lately, the 10-year Treasury has been stuck in the 2.5% to 2.75% range, and market volatility has decreased.Investors, however, shouldn’t expect this calm to continue come September. While I still believe US and global equity valuations are reasonable and stocks can advance over the next year, market volatility is likely to increase in September for four reasons:
1.) September is the one month of the year when the calendar really does matter. Looking at data on the Dow Jones Industrial Average back to 1896, September has historically been the worst month of the year for stocks, with a consistent, and statistically significant, negative bias.
This September swoon phenomenon extends beyond the United States. September has also historically been the worst month of the year in a number of European markets – including Germany and the United Kingdom – and in Japan.
2.) Anxiety over Fed tapering is likely to climb as we approach the Fed’s September meeting.
3.) Europe is likely to re-emerge as a source of volatility as Germany holds an important federal election in September.
4.) The US budget debate will heat up again as Congress needs to pass a continuing budget resolution before the fiscal year ends on September 30th. Not surprisingly, Congress has made little progress to-date.To be sure, September did not play to script last year and September’s negative seasonal bias is much less pronounced in years when the market is up year-to-date, as clearly is the case this year. But last year’s September rally had a lot to do with more-than-expected support from the Fed, something we aren’t likely to see this year.How should investors position their portfolios ahead of a probable volatility uptick next month? As I write in my latest weekly commentary, in preparation for a possible September swoon, I advocate being more defensive going into the fall. In particular, I would consider lightening up on parts of the market that look particularly extended year-to-date such as US small caps and US retailers.In addition, investors may want to consider investments that offer the potential for downside protection, including minimum volatility funds like the iShares MSCI ACWI Index Fund (ACWI) ; mega-cap companies, accessible through funds such as the iShares S&P Global 100 Index Fund (IOO); and international dividend firms, which can be accessed through funds like the BlackRock Global Dividend Income Fund (BABDX).Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to The Blog. You can find more of his posts here.Source: BloombergThe author is long IOO