Wall Street's five-month-long rally has halted in September, the historically worst-performing month in Wall Street. But this year it was more than that as all the three major stock indexes — the Dow, the S&P 500 and the Nasdaq Composite — tumbled 2.3%, 3.9% and 5.2%, respectively, to record their worst September since 2011.
At present, economists and financial experts are busy assessing how October will behave — will it see the continuation of a downturn and almost day-to-day fluctuations or will the month turn the wheel and put the market back in a northbound trajectory? Although no clear-cut inference can be drawn at this stage, several important factors, both negative and positive, for October are clearly visible. Let's discuss these in detail.
Sources of September's Volatility Persist
The factors that led to severe volatility last month are present in October too. A spike in new coronavirus cases, lack of a vaccine for COVID-19, uncertainty about the second round of fiscal stimulus despite repeated warning from the Fed and several economists, and intensifying geo-political conflict between the United States and China are all present in October.
Moreover, this is the month before the U.S. presidential election scheduled on Nov 3. Historically, stock markets have remained volatile in the month before the election. Market participants generally choose to hold cash instead of investing in risky assets like equities while assessing the economic and financial consequences of the election result.
This is evident from the COBE VIX reading — popularly known as the best fear-gauge of Wall Street. The VIX indicates market's expectation of a 30-day forward-looking volatility based on the near-term S&P 500 Index options (both puts and calls).
Notably, VIX is currently hovering in the range of 25 to 30 while it was in the range of 21 to 23 in mid-August and surged around 35 to 36 in mid-September. At its current level, the fear gauge is well above its last year's average range of 12 to 15 and its long-term reading of around 20.
At its current level of 26.38, the VIX is higher than its 50-day moving average of 25.22. In financial literature, the 50-day moving average line is generally recognized as the short-term trend setter. This indicates that the market will remain volatile and stocks will swing widely in either direction in the near future.
Positive Catalysts for October
First, the market's meltdown in September was broad-based. Except for a marginal gain in the utility sector, all 10 other broad sectors of the S&P 500 suffered stiff losses last month. Aside from technology, cyclical sectors like consumer discretionary, industrial, materials and communication services also declined sharply. Therefore, the market is no longer as overvalued as it was at the beginning of September.
Second, despite the termination of the CARES (Coronavirus Aid, Relief, and Economic Security) Act in July, U.S. consumers confidence has jumped in September and reached its highest level during the pandemic period so far. A robust housing market, strong vehicle sales, expansions of manufacturing activities and better-than-expected core durable goods orders, clearly indicates fundamental strength in the U.S. economy.
Some economists have raised eyebrows regarding the slowing growth of job data and retail sales data in August. However, the vital point here is that these segments are still growing, albeit at a slow pace, despite the lack of the second tranche of fiscal stimulus amid continued coronavirus-led woes.
Third, in its latest projection on Sep 25, the Atlanta Fed estimated 32% growth for third-quarter U.S. GDP. Furthermore, projections for U.S. corporate earnings for third-quarter and full-year 2020 are rising since early July, indicating growing corporate profits.
The earnings trend is likely to improve going forward as large parts of the U.S. economy have started coming out of the pandemic-driven lockdown. Since the coronavirus-led lockdowns in March, the U.S. economy is operating at a sub-optimal level. The reopening of the economy will limit the stock market's downside potential.
Fourth, the Fed's ultra-dovish monetary stance is a long-term positive for the stock market. On Sep 16, Fed Chairman Jerome Powell reiterated that the benchmark interest rate will stay zero or near zero at least up to 2023. A low interest rate will reduce the cost of capital for businesses and consumers will have a lesser propensity to save due to a low deposit rate.
Therefore, higher spending by businesses and consumers is likely to boost the overall economy and raise stock prices. Moreover, a low discount rate will increase the net present value of the investment in equities.
How to Pick the Right Stocks
At this stage, it will be prudent to invest in large-cap (market capital > $50 billion) stocks with a favorable Zacks Rank. These companies have well-established businesses, solid liquidity and brand names. Also, we have select stocks with strong short-term and long-term (3-5 year) growth potential that have witnessed robust earnings estimate revisions within the last 60 days.
Major stocks that fall in this category include Zoom Video Communications Inc. (ZM - Free Report) , salesforce.com inc. (CRM - Free Report) , Activision Blizzard Inc. (ATVI - Free Report) , Target Corp. (TGT - Free Report) , FedEx Corp. (FDX - Free Report) , NIKE Inc. (NKE - Free Report) and Deere & Co. (DE - Free Report) . Each of our picks carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The chart below shows the price performance of seven above-mentioned stocks in September.
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