September historically has been the worst month for stock performance going back nearly seven decades, but Bank of America sees the potential for short-term gains even as trade tensions raise the risks of a recession, in the opinion of many analysts. BofA's contrarian view is based largely on rising caution and pessimism among investment professionals, seeing this instead as a cause for optimism about the direction of stock prices.

"In August, our Sell Side Indicator - Wall St. strategists' average recommended equity allocation - fell to a two-year low (54.2 from July's 56.2), the biggest monthly decline in six years...which is bullish," BofA writes in a report released this week, noting that "light positioning represents near-term upside risks. Furthermore, supportive central banks and negative sentiment are supportive."

Key Takeaways

  • September is historically the weakest month for stocks.
  • However, Bank of America sees upside potential right now.
  • BofA finds rising caution and pessimism to be bullish indicators.

Significance For Investors

Based on data since 1950, LPL Financial finds that September has, on average, been the worst month for the S&P 500 Index (SPX). The average return in September has been a gain of 0.5%, but performance has been better during the past decade, with an average gain of 0.9%. This year, the S&P was down by 1.8% in August.

BofA also sees profits in those dismal numbers by using another investor positioning indicator, which tracks 18 measurements related to asset flow, sentiment, and price, as Michael Hartnett, chief investment strategist at its Merrill Lynch division, observed in a note to clients cited by Barron's. Hartnett says that this indicator has fallen to its most bearish reading since January, and he interprets this in a contrarian fashion, as a buy signal for risk assets such as stocks. Asset flows out of stocks and emerging market debt, plus outperformance by U.S. Treasury bonds compared to corporate bonds, were key drivers of the decline in the indicator.

Since 2000, the BofAML positioning indicator has had a good predictive record, Barron's observes. When it flashes a buy signal, the median gain for global stocks over the next three months has been 6.3%, and the median increase in the yield on the 10-Year U.S. Treasury Note has been 50 basis points (bps). Also, on average, stocks outperformed investment grade bonds by more than 10 percentage points, while high yield bonds outperformed government bonds by more than 6 percentage points.

Looking Ahead

If the buy signal issued by the BofAML positioning indicator is correct, the S&P may approach 3,000, or 2.6% above the Sept. 4 open, while the yield on the 10-Year T-Note may rebound to about 2.0%, Barron's indicates. On the other hand, bond prices have surged on expectations that central banks will keep cutting interest rates. If these expectations are not met, an asset price bubble may burst, possibly sending the economy into recession as interest rates shoot upwards, Hartnett warns.

Michael Wilson, chief U.S. equity strategist at Morgan Stanley, shares that concern. He's "watching for signs of demand destruction" as a new round of U.S. tariffs on imports from China take effect in September, per his current Weekly Warm Up report. He sees a vicious cycle emerging in which tariffs, slower job growth, and market volatility depress consumer sentiment and consumer spending, leading to weaker corporate profits, and causing yet slower job and wage growth.