August is traditionally a lousy month for stocks – second only to September in terms of terrible performance.
And this August is living up to that billing.
Stocks (S&P 500) have lost 5% already this month, and have dropped on 10 of the first 13 trading days we’ve seen.
The light trading volume that’s an August hallmark – with so many folks away on vacation or otherwise disinterested in stocks – is a key ingredient of this month’s lackluster performance over time.
And that light volume plays to the strengths of algorithmic and high-frequency traders who really make hay when Wall Street’s away.
Anytime volume dries up, algorithms can jump in and muscle around stocks that have less liquidity and therefore wider spreads between the bid and offer prices. Those algorithms actually lay in wait – constantly testing liquidity until a tipping point comes and they can exploit the spreads by trading at blazing speeds.
In normal trading, they make a mere fraction of a penny per trade… but they do it over and over again … millions and millions and millions of times.
On volatile days – when the spreads widen from a fraction of a penny to several pennies – it adds up to even more cash.
That’s why the high-frequency folks are popping champagne bottles when most other investors are drowning their sorrows.
I relate to all this from personal experience: I’m a “systems” (algorithmic) trader myself – but not of the high-frequency variety.
Despite some of the negative press algorithmic trading has generated through the years – program trading was blamed for the 1987 stock-market crash and high-frequency trading was blamed for the 2010 “flash crash” there’s nothing nefarious about computer algorithms. They’re simply step-by-step instructions to complete a task or solve a problem.
The algorithms I designed to power my Quantum Edge system solve a major – and very specific – problem: How do you sort through 6,000 stocks every day to find the handful you can really make money with?
I wrote the instructions, and the computers do what they’re told. They analyze and rank more than 6,000 stocks every night — something that would take even the smartest person weeks or months to accomplish.
I then use the results to identify the best opportunities – the highest-quality companies whose shares are trading at just the right prices – in the market.
In the current volatility – which is neither surprising nor unhealthy – some of those cream-of-the-crop stocks are cooling off after being too hot to touch.
Much of the choppiness is from computers simply following instructions in low-volume trading. The strong market has not suddenly turned sour. It’s a well-established pattern that starts with Wall Street leaving town and continues a few more weeks after Labor Day.
Then comes the strongest stretch of the year – by far – for stocks.
And guess what? Those very same algorithms taking advantage of downside volatility today can flip to buying in a heartbeat.
Now is the time to buy stocks for what I expect will be a fun and profitable finish to 2023. This year, it could easily be more explosive than usual because multiple catalysts are converging at just the right time.
Catalyst #1: It’s What Stocks Do
The data is clear as can be.
There’s no reason to overthink this.
I’ve shared this chart a lot recently because it tells the whole story:
The fourth quarter is the absolute best for stocks, and the weakness in August and September is the perfect time to buy. I think this fourth quarter could be better than usual because…
Catalyst #2: Rate Hikes Are Done – Or Should Be
The Federal Reserve began raising interest rates a year and a half ago to fight inflation. Eleven increases later, rates are as high as they’ve been in 16 years. The pressure is now on the Fed to stop before overdoing it and possibly damaging the economy.
Investors now overwhelmingly anticipate that the Fed will leave rates alone at its next meeting a month from now. CME Group’s FedWatch tool shows that investors assign an 86.5% probability of no change.
Big Money has already been investing for the end of rate hikes, which has helped drive the market higher. Buying has slowed here in summer, but that’s to be expected.
When the Fed signals that it’s done raising rates – and perhaps even starts talking about rate cuts – the fuse will be lit.
We are close because…
Catalyst #3: Inflation Is Cooling
The Fed’s war on inflation is working.
You and I don’t like paying higher prices for groceries, gasoline, eating out, vacations, or anything else. But things have improved dramatically. Inflation is closer to the Fed’s target rate of 2%:
Higher interest rates have done their job. And as I wrote earlier this month, rates bumped up on their own after U.S. debt was downgraded, which takes even more pressure off the Fed to keep hiking.
Higher rates have also cooled the economy, which was a necessary side effect. But the economy has proved amazingly resilient and surprised an awful lot of folks with its strength.
We see this strength because…
Catalyst #4: Companies Continue Making Money – And Expect to Begin Making More
The data is equally compelling here.
With the last earnings reporting season essentially complete, the beatdown so many folks expected didn’t happen.
According to FactSet, 79% of S&P 500 companies earned more than expected, which is higher than the five-year average. And 65% generated more sales than expected.
That’s not to say companies aren’t feeling the pinch. Overall earnings on the S&P 500 declined 5.2%. But they were still better than expected, which is arguably more important to investors than the actual results.
Even more encouraging, last quarter was likely the worst of it – the “earnings trough.” Analysts estimate slight growth (0.2%) here in the third quarter, followed by much more impressive 7.6% growth in Q4.
Which, of course, just happens to be the strongest quarter for stocks anyway.
Expect money to flow into stocks as rate hikes end and earnings grow. And there is a lot of it ready to flood in…
Catalyst #5: Tons of Fuel for Stocks to Launch
There is $5.7 trillion in money market accounts, according to the Fed’s latest report, which is far and away the most ever. It’s about one-fifth of the entire U.S. economy.
That’s more than enough fuel for a Sunday drive. That’s enough for a cross-country adventure.
It’s also a record amount of cash just sitting there. Investors stung by 2022 have resisted the bull market of 2023, to their detriment.
But they can’t much longer. Money managers aren’t paid to park funds in cash. They’re paid to grow funds, so there’s an inherent pressure to have that money working.
Once we get through the next few weeks and these catalysts kick in, FOMO (“fear of missing out”) will also kick in. And that’s when we should see a tidal wave of cash coming back into stocks.
The Stocks to Buy Now
You don’t want to miss what could be an extra special quarter to add profits if you’ve been investing or make up for lost time if you’ve been underinvested.
Volatility doesn’t discriminate. Even the absolute best stocks feel the heat.
That’s when mouth-watering bargains pop up.
Buying the strongest stocks in the market at lower prices increases profit potential and lowers risk.
I’m seeing more of these opportunities in my stock screens. Stocks with high Quantum Scores are fading to prices that are too good to pass up.
Stocks with high Quantum Scores have the best fundamentals in the market, some of the strongest technicals you can find, and Big Money flowing in. These are the stocks most likely to run a lot higher in the fourth quarter.
Our Quantum Edge system win rate is roughly 70% historically, and that’s through all market conditions. These kinds of stocks have an even higher win rate and bigger moves when the overall market is also rocking and rolling.
They are the kinds of stocks you want to buy right now.
You probably still have some time to get in position before the end-of-year rally starts, but I wouldn’t wait much longer. The fact to the finish could begin anytime.
If you want the benefit of investing in stocks with high Quantum Scores, you can click here to find out more.
Jason Bodner’s Power Trends