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Can the S&P 500 Return to Record Highs and Its Bull Trend in the Summer Doldrums?

Can the S&P 500 Return to Record Highs and Its Bull Trend in the Summer Doldrums?

2018-08-08 03:05:00
John Kicklighter, Chief Currency Strategist

Talking Points:

  • Historically, August is the lowest activity (via volume) month of the year for the S&P 500 (a benchmark for 'risk trends')
  • Such seasonality is the product of liquidity, but the summer drain is more habitual than exchange based - making it uncertain
  • Shallow markets can undercut the development of trends; but amid trade wars and other risks, it can also spur volatility

What makes for a 'great' trader? Strategy is important but there are many ways we can analyze to good trades. The most important limitations and advances are found in our own psychology. Download the DailyFX Building Confidence in Trading and Traits of Successful Traders guides to learn how to set your course from the beginning.

Seasonality is a Function of Liquidity

There is always the potential for the markets to take a sudden lurch towards record highs or to topple into utter collapse. However, during certain periods, the probability of such dramatic moves is severely curbed. While there are technical and fundamental barriers that can shape the market's ability to conduct trend and volatility, arguably far more influential are the effects of liquidity. When the market thins out to a skeleton crew, rousing a significant charge is difficult enough. Mounting a genuine and lasting trend is nigh impossible. Market depth is a certainly a function of circumstance, but it can also be heavily influenced through seasonal changes. For certain time frames - like the Western world's year-end holiday period - there is a host of exchange closures that forcibly drain market depth. And, without a market to actually fulfill a shift in speculative view, trends in such periods quickly find themselves snuffed out like a flame without oxygen. There are also periods where there isn't a technical cap on the market, but rather habit solidifies anticipation and ensure a curb on activity just as surely as if there were no market at all.

Can the S&P 500 Return to Record Highs and Its Bull Trend in the Summer Doldrums?

The Summer Doldrums and the Proximity of Records

Among those periods where habit is more important than exchange closures to ater the course of trading conditions, there is perhaps no other time more recognizable than the 'summer doldrums'. This common trader's term references the period through certain summer months for the Northern hemisphere where markets tends to quiet as speculative ambition seems to peter out. There are few and sporadic holidays for the global markets through between July and September, but there are engrained assumptions that other market participants will abide by the unspoken rule of status quo and therefore other traders will follow suit for a self-fulfilling outcome. In terms of quantifiable movement, the turn over through August is by far the most reserved month for our benchmark S&P 500. Volume for the benchmark index through the month is by far the most reserved of the year (when adjusted for trading days). That said, the average performance of the VIX through August is in the midst of a climb that peaks in September and October. As it happens, September is the worst month on average for the US index and the volatility index surges in the subsequent month to its peak in the calendar year. The draw of habit and years of complacency will act to keep the markets under wrap for the coming weeks. However, we are dealing with so many open-ended and significant fundamental themes (trade wars, monetary policy, etc) that it would be negligent to dive into the comfort of illiquidity as a basis for confidence.

Can the S&P 500 Return to Record Highs and Its Bull Trend in the Summer Doldrums?

Application for Trading the S&P 500, Dollar, Pound, Aussie and Canadian Dollars

With the proper motivation - the trade war erupting genuinely between the US and EU, a hard Brexit or the overt failure of global monetary policy - the markets can overcome their shortcomings for participation and muster a substantial drive. However, these instances are very uncommon and not difficult to register as they unfold. So, barring the improbable, it is more likely that breakouts stall, range boundaries reject efforts at break and conformity takes over for more persistent market development. We could use these norms to help avoid destructive setups and pursue more probable scenarios. The S&P 500 is a great example of this quandary. As it hovers just below record highs, we have to weigh how much conviction is there behind this incredible push. A break to record highs is a rather robust probability but purposeful follow through would be a separate matter altogether. Therefore, a range strategy would better align to probabilities. The same is true of the dollar. The US Dollar finds itself in exactly the same impasse. Just off of a 13-month high, we are at the upper boundary of a trade band. A bullish break would appeal to those watching pairs like EUR/USD, but the capacity for follow through in these circumstances is extremely thin. We could make the same evidence-based assumptions that a DXY break higher or EURUSD slide below 1.1500 is possible, but follow through would be in spurts and fits. Less systemic in nature, but offering sharp volatility just lately, the Aussie and Canadian Dollars have also move to the top of many traders' lists. The sharp rally for the former and drop for the latter cleared impressive technicals and aroused starved traders, but these currencies don't even have meaningful data to supplement reserved conditions. We discuss the effect of seasonality conditions and illiquidity in today's Quick Take Video.

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