Happy Labor Day 2018. And enjoy the break while it lasts. Because September is often a drag for the stock market, and a wave of new bond issues this time around could weigh on credit markets, too.
As market strategists and our own Randall Forsyth have observed, September has historically been the worst month for U.S. stock market performance. And U.S. equities are not exactly cheap at the moment, even after tax reform cranked up corporate earnings. The S&P 500 and the Dow Jones Industrial Average are both trading at a rate more than 20 times their earnings for the past 12 months, well above their long-term averages of 16-times and 15 times, respectively.
But this year the concern this year is global. Ned Davis Research found that September often brings slumps for the MSCI’s All-Country World Index (ACWI) as well. The index “appears vulnerable to rising volatility and downside momentum now that we’ve entered the time of the year when market carnage has been most common,” NDR‘s Tim Hayes, chief global investment strategist, wrote in an Aug. 16 note.
The ACWI’s history of September underperformance may simply be the result of the U.S.’s gravitational pull, as more than 50% of the index’s value is made up of U.S. equities. Even so, NDR expects the worst of this “carnage” to be in emerging markets.
The Federal Reserve is widely expected to raise rates at its September meeting, market prices show. So developing economies with significant external public or private financing needs (notably Turkey and Argentina) could face more pressure if their currencies continue to decline against the dollar.
NDR says global investors should reduce their exposure to emerging market equities: While its benchmark allocation is almost 12%, it recommends global investors limit such equities too 9% of their portfolios.
Corporate debt may not be the best place for investors to hide, however. That market could be inundated with other September issues — specifically, companies issuing new debt to finance mergers and acquisitions.
The dollar amount of investment-grade bonds issued to finance deals is up 22% from last year, and this pile of new debt will likely continue to grow, according to an Aug. 29 note from strategists at Bank of America Merrill Lynch.
Analysts at CreditSights estimate that $164 billion worth of bonds still need to be issued to finance M&A deals. The largest will be T-Mobile’s purchase of Sprint, which will require $30 billion of investment-grade bond funding. Other deals that still need to tap debt markets include Takeda’s tie-up with Shire ($20 billion of debt) and Disney’s bid for Fox ($20 billion).
Strategists at Bank of America Merrill Lynch argue that expectations for a wave of investment-grade supply caused the asset class to underperform in late August. But if new issuance remains below $150 billion in September, they say, the bonds could end up rallying and spreads could narrow 5 to 10 basis points.
The “wild card” is health insurer Cigna’s merger with pharmacy benefits manager ExpressScripts, which was approved by shareholders in late August. If it decides to issue bonds to finance the deal before its regulatory approval, that could lead to an additional $23 billion of new debt supply and push the month’s total above $150 billion. Such volume, Bank of America Merrill Lynch says, could “push spreads wider for the month of September.”
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