August Is More Grumpy Cat than Ferocious Lion
Thursday, July 31, 2014

Judging by the 70-degree weather we’ve been having in here in Chicago, it’s hard to believe that August is starting tomorrow. But the calendar does not lie. For summer enthusiasts living in northern climates, the month represents the last chance to enjoy long hours of daylight and wear shorts outside. For investors, August has a different connotation.

August was the best month of the year for stocks during the first half of the 20th century. Mark Hulbert published a column on MarketWatch saying the month remains one of the better ones when the entire history of the Dow is considered. Using data from 1896 through 2013, Hulbert calculates an average August return of 1.13% for the Dow. This is the fourth-highest return of any month. Jeff Hirsch at the Stock Trader’s Almanac says that August’s performance is a tale of two long periods. While August was a great month between 1901 and 1951, it hasn’t been since. The Dow has experienced an average decline of -0.1% since 1950. The negative return makes August the fourth-worst-performing month.

Note the size of the decline: -0.1%. It’s not anywhere close to being big enough to justify the transaction and tax costs you could incur from pulling out of the market. In fact, most daily fluctuations in the Dow are larger. The danger, of course, is incurring a decline of greater than 0.1%. Big drops have occurred in August before. A combination of events, including the Long-Term Capital Management implosion, led to a 15.1% drop in 1998. Saddam Hussein triggered a 10% slide in 1990 when he invaded Kuwait. More recently, the sovereign debt crisis in Europe led to a 4.4% slide in 2011.

The average return figures mask a key point: the odds of whether August is likely to be up or down. Hirsch’s data shows the Dow realizing an August gain during 36 out of the last 64 years (59% of the time). The average is negative, however, because previous big drops have dragged August’s long-term performance down. If the market drops caused by the downfall of Long-Term Capital Management, Iraq’s invasion of Kuwait and the European sovereign debt crisis hadn’t all occurred in August, the month’s average return would be different.

Nonetheless, August has a reputation for being a lackluster month. Trading volume can be lower as summer vacations are taken. Earnings season subsides, creating an air pocket for financial news. Hirsch cites the United States’ shift away from being an agrarian society as playing a role for moving August from the good to the subpar column.

As this year’s August starts, the bull market remains intact (even with today’s drop). The economy is continuing to grow, as are corporate earnings. The Federal Reserve is still in no rush to raise rates. On the other hand, we have gone for a long period without a correction and upward trends only last until they don’t. The CBOE Volatility Index (the “VIX”) has been creeping up over the past few weeks. Stock valuations are certainly not cheap, even though they aren’t overly expensive either. The new sanctions against Russia could impact the recovery in Europe.  There is also the possibility for a wildcard event nobody is focusing on, but that risk is always hiding underneath Mr. Market’s bed.

If we had a functioning crystal ball, determining whether this August will be a ferocious lion or merely Grumpy Cat would be easy. We don’t. We do know that the post-World War II odds favor staying disciplined with your sell rules and keeping an eye out to see if the opportunity to buy stocks on sale emerges. More importantly, what really matters isn’t how good or bad August is, but rather your ability to stick with a disciplined approach regardless of what the headlines and the calendar say.

More on

The Week Ahead

71 members of the S&P 500 will report earnings next week. The only Dow component in this group will be The Walt Disney Company (DIS), which will report on Tuesday.

The first economic reports of the week will be June factory orders and the July non-manufacturing ISM survey, which will both be released on Tuesday. On Wednesday, June international trade will be reported. The week will conclude with the release of second-quarter productivity data on Friday.

What’s Trending on AAII
  1. How Much Small Cap Should Be in Your Portfolio?
  2. Achieving Greater Long-Term Wealth Through Index Funds
  3. Five Common Traits of Successful Value Screens
AAII Sentiment Survey

Pessimism among individual investors is above 30% for the first time since mid-April. Nonetheless, the percentage of bulls and bears is evenly split in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 1.5 percentage points to 31.1%. Even with the rebound, this is the seventh consecutive week and the 18th time in the past 20 weeks that optimism is below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 2.7 percentage points to 37.8%. Even with the decline, neutral sentiment is above its historical average of 30.5% for the 30th consecutive week. This is the third-longest streak of consecutive weekly readings above 30.5% in the survey’s history.

Bearish sentiment, expectations that stock prices will fall over the next six months, increased 1.2 percentage points to 31.1%. This is the first time pessimism is above its historical average of 30.5% in 15 weeks.

This is the first time there has been an equal percentage of bulls and bears in our survey since September 6, 2012.

Since reaching a short-term bottom of 21.3% on June 12, 2014, bearish sentiment has risen by a cumulative 9.8 percentage points. The rebound in pessimism is occurring as the S&P 500 has failed to consistently set new highs and geopolitical tensions have heightened. Some AAII members have concerns about prevailing valuations, events in the Middle East and Ukraine, the pace of economic growth and Washington politics. Other AAII members remain optimistic about sustained economic growth, the market’s upward trend and the Federal Reserve’s tapering of bond purchases.

This week’s special question asked AAII members how important it is for a company to buy back its shares. Though the responses varied, one theme appeared regardless of a member’s opinion about buybacks: Other uses of cash should be given priority before shares are repurchased. Nearly 17% of all respondents said dividends or growing the business should take precedence over buybacks.

In terms of how necessary it is for a company to buy back shares, 30% of respondents said share repurchases are not important. The second-largest group (23%) said stock buybacks are important or otherwise viewed them favorably. Several of these respondents said share repurchases show optimism on the part of management, while some others liked buybacks only if they reduced the number of shares outstanding or offset employee stock awards. Approximately 13% of respondents said their opinion depends on factors such as which other uses for cash are available or the reasons behind the buyback. Slightly more than 10% of respondents were against share buybacks. Some of them thought buybacks signal that there is not a better use for cash, while others wanted the money to go to raising dividends instead.

Here is a sampling of the responses:

  • “Not important at all, though I would rather see a company use its money for dividends as opposed to buybacks.”
  • “Depends on what other things the company is doing. Generally, I look very favorably on companies that buy back their stock.”
  • “I believe it is a good thing if conditions such as valuation and free cash flow give merit.”
  • “They are a warning sign that management has not found better opportunities for growing the business.”
  • “Not important. I would rather see dividends or capital investment.”
  • “I am concerned that companies buy back stock when the price is high.”

This week’s Sentiment Survey results:

Bullish: 31.1%, up 1.5 points
Neutral: 37.8%, down 2.7 points
Bearish: 31.1%, up 1.2 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!