If you’re looking for reasons why U.S. equities might have a hard time making new highs in September, you might very well just point to the dollar, which has risen steadily after taking a breather in mid-August.
That’s trouble for emerging markets and we’ve reached the point where most commentators think it’s going to be difficult for U.S. risk assets to push much higher in an environment where the rout in EM continues apace.
In short, we might have reached “peak divergence” last month between U.S. equities and the rest of the world. The following visual shows the normally positive longer-run correlation between the S&P and the MSCI EM index breaking down entirely of late, underscoring the divergence:
In order to avoid a scenario where the turmoil in developing economy assets finally spills over, that turmoil needs to stop, and the best way for EM to get some relief is via a weaker dollar.
But if you’re looking for non-EM-spillover reasons for being cautious on U.S. equities this month, Deutsche Bank’s Binky Chadha has a list for you.
First, Chadha notes that the S&P 500 is at the top of its trend channel. “Following the February correction, since April the S&P 500 has risen in a clear trend channel (+1.7% a month; span 3.3% top to bottom)”, he writes, in a note dated Tuesday, adding that while “strong macro and earnings growth offset the risks from emerging markets and trade policy [and] buybacks offset outflows and cuts in positioning, near term, the 1.2%-1.7% potential upside over the next month along the top of these channels needs to be traded off against the 3.3% potential downside to the bottom, making the risk-reward not very compelling.”
Second, Chadha simply observes that “we are now 47 trading days since the last 3-5% pullback that has historically occurred every 2-3 months (48 days) on average.” In other words: We’re due.
Third, Deutsche Bank reminds you that seasonality is not on your side. “Historically September stands out as the one month when the S&P 500 has on average been down, by 1% [and] losses have been slightly more in mid-term election years”, Chadha continues.
Fourth, the macro is rolling over or, more accurately, the Citi economic surprise index has turned negative for the U.S. (more on that here).
Finally, geopolitics beckons. Here’s Binky outlining the minefield markets will attempt to navigate between now and the midterms:
Geopolitical risks remain while corporate news will be limited near term and the buyback black out period is approaching. The list of risks includes those ongoing from trade policy, emerging markets, and Italy. In the near term, we expect noise around the US mid-term elections to increase. With a typical mid-term election outcome entailing a switch to a Democrat majority in the House, talk of potential impeachment is likely to become more frequent. Historically, geopolitical risks have been associated with sharp (-6.4%) short-lived equity selloffs (3 weeks to bottom; 3 to recover), with the subsequent trajectory driven by macro growth and earnings. There is little to distinguish the pullback episodes around the impeachment proceeding against Presidents Clinton and Nixon from other geopolitical risk episodes. In between earnings seasons, in the near term corporate news will be sparse while, as the month progresses, the buyback blackout period begins in the run up to earnings, both of which have been the key drivers of the market uptrend and offsets to the risks.
True to form, though, Chadha is generally upbeat. If you can characterize the above as “cautious”, then it’s a tactical call rather than a downbeat assessment of the outlook.
Ultimately, he’s sticking with his 3,000 year-end S&P target, citing multiples that have come in from peaks, still robust U.S. econ and, of course, buybacks.