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Keep Your Powder Dry

Summary

  • Market volatility tends to move higher in late summer as trading volumes get thinner.
  • During these testing times, economic news tends to have a bigger psychological impact, not just on investors, but also on consumer confidence.
  • Investors may eventually see some compelling opportunities to step in. In the meantime, keeping your powder dry and booking some gains would seem prudent.

Market volatility tends to move higher in late summer as trading volumes get thinner. During these testing times, economic news tends to have a bigger psychological impact, not just on investors, but also on consumer confidence.

As a case in point, euro zone retail sales fell by 0.6 percent in June. While June's year-over-year performance was still positive, its 1.2 percent growth represented the weakest reading so far this year. In Germany, the euro zone's largest economy, retail sales fell 2.3 percent month over month in June as headlines and consumers focused on continued instability in Greece. Analysts had predicted 0.3 percent growth. These data points highlight just how fragile consumer sentiment can be.

Chinese consumers are also showing signs of headline fatigue. China overtook the United States as the world's largest automotive market in 2009, but in June, growth in year-over-year new car sales fell into negative territory for the first time in over two years, a clear sign that the decline in Chinese equity prices is negatively affecting consumer sentiment. Additionally, the Caixin manufacturing purchasing managers index (PMI) for July dropped to a two-year low of 47.8.

Flagging markets outside the United States increase its safe-haven status in the minds of investors, especially for U.S. Treasuries. But here, too, uncertainty is dampening buyers' moods. The U.S. Federal Reserve's post-meeting statement last week set the stage for a rise in interest rates sometime later this year, but the tone of the statement, while hawkish, also stressed a lack of exigency. Without any concrete guidance, investors will scrutinize the summer's many forthcoming economic data releases for any insight into the Fed's timing. Ultimately, we will get a Fed rate increase and the market will inevitably have to come to terms with it, but the transition will not be smooth. All told, I anticipate an even wilder ride in the months ahead than the one we have already endured. Outcomes, such as a decline in U.S. equity prices or a sharp decline in interest rates, are not unlikely or unexpected.

Given this current backdrop, I see no urgency to put money to work. There is very limited upside for risk assets, and probably some meaningful downside over the course of the next few months. Nevertheless, the U.S. economy remains strong, and until we start to see some sort of decay in leading economic indicators, I'm not overly concerned that the current expansion is coming to an end. I do believe, however, that caution is still the watchword for the months ahead. Investors may eventually see some compelling opportunities to step in, probably in the energy sector. In the meantime, keeping your powder dry and booking some gains would seem the most prudent thing to do.

Summer's Poor Risk-Return Tradeoff

The summer months have become synonymous with market underperformance. Using the Sharpe Ratio as a measure of risk-adjusted return, the chart below indicates that the May-to-September period offers the lowest average excess return on the S&P 500, per unit of volatility, when measured against 10-year U.S. Treasury yields. August and September have an especially poor historical risk-return tradeoff.

S&P 500 Sharpe Ratio Seasonality over the Past 25, 50, and 75 Years

Source: Bloomberg, Guggenheim Investments. Data as of 7/31/2015. Note: To ensure comparability, months with negative Sharpe Ratios were tested with the Israelsen-Modified Sharpe Ratio, which returned near-identical performance ranking within each data series.

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This material is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author's opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2015, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.


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