It’s surprising that we’re halfway through the month of August, and yet nobody has made mention of the strong seasonality the markets are currently bucking.
Since 1990, the S&P 500 has averaged a return of 1.1% for the month of August. To the surprise of most investors, this ranks August as the worst monthly performer of the year.
Looking at a closer breakdown of the historical data, August presents one of the worst risk/reward seasonalities. While the S&P 500 has finished in the green 55% of the time, the average return of these winning Augusts is only 2.3%. On the other side, the month of August averages the worst losses, posting an average loss of 5.1% for 45% of the time.
The large risk inherent in August’s losers suggests that the seasonal risk/reward proposition of the market for August is decidedly negative and perhaps worth skipping out on altogether.
So, with the S&P 500 up nearly 3% for August so far, is it time to call this month a winner? Not so fast. As we head into the second half of August, there are a few signs that the market might be ready to yield to some resistance.
First, low VIX readings imply that the market might hit some resistance sooner rather than later. Last week’s VIX close represented the lowest close in 2012, signaling that option prices are factoring in a continuation of the low-volatility environment into September. The VIX followers out there know that low VIX readings often mark points where the market is more likely to run into short-term resistance because of investor complacency, so you should be on your guard.
In addition to identifying potential complacency, the low VIX readings also imply that the time might be right to buy some portfolio insurance. A low VIX means that premiums on protective puts are a relative bargain. For example, at-the-money puts on the SPDR S&P 500 ETF (NYSE:SPY) are roughly 8% cheaper than they were a month ago, meaning that the cost to “insure” your portfolio with these puts is significantly cheaper.
For now, the safe bet of taking advantage of cheap premiums to protect a portfolio appears wise, as August seasonality and potential resistance could stall the recent straw-man rally.
As of this writing, Chris Johnson did not hold a position in any of the aforementioned securities.