To get a sense as to just how docile the market has been, check out the below chart of the volatility index. It has been bumping along at incredibly low levels. When this happens, it shows how complacent things are…and usually portends a change.

That being said, while we look forward to more market activity, perhaps it is best to be careful what you wish for. Because, although we remain positive on the US economy, and are feeling good about small cap shares at this time, history is not necessarily on the side of the bulls as we enter the month of September. Check this next chart out…

As the graph clearly demonstrates, September is the cruelest month of the year to be an equity investor. It’s not even close. Why is September historically so bad? We are scratching our heads about this, like the rest of you. However, no good question should go unanswered, so we Googled it and here are a couple of possible explanations.

"A University of Kansas study suggests a sharp drop-off in the amount of daylight in New York in September might trigger seasonal affective disorder and make some traders more risk-averse. On average, New Yorkers see 3,147 fewer minutes of daylight in September than they do in August, the biggest drop of any month"…from Business Insider

 "Sam Stovall, equity strategist for S&P Capital IQ, has argued investors tend to ditch lackluster stocks before third-quarter earnings results start trickling in. Others have suggested traders who follow the old dictum “Sell in May and go away” return from their Labor Day sojourns eager to sell off positions that have since become undesirable. These patterns may also account for greater volatility as summer gives way to fall"…from IB Times

Like we said, these are possible explanations, but, frankly, we don’t buy into any of them (especially the one about how the people who sell in May come back after Labor Day and sell…really?). This just goes to show how there is no real explanation for this phenomena. Yet, it happens pretty consistently.

That being said, however, at Sylva Capital, we are in the camp that history may very well end up repeating itself in 2016.  In our opinion, the market appears poised for a tough September for one reason…complacency. As a group, market participants seem to be shrugging off any and all negative economic data, continuing to push stocks to new highs. Admittedly, there is a TON of cash out there. Central Banks have the spigots wide open…but all that really does is just add to the complacency as traders have now become absolutely convinced that the Fed will ride to their rescue on any market pullback; an action commonly referred to as the “Fed Put”.

Now, this Fed Put may or may not exist, but it really doesn’t mean that stocks can never go lower. As we saw during the early part of 2016, this is quite possible and it can happen rather quickly. Meanwhile, this complacency is allowing the market to overlook one key metric that has turned increasingly negative.

We do acknowledge that dislocations between two related data sets happen often and can sometimes be greater and last longer than ever imagined. However, entering the weakest month of the year, we feel it’s important to highlight one metric that is getting distorted more than we’ve ever seen; that metric is the performance of the S&P 500 relative to its constituents’ earnings growth. It’s only natural that the two would trade in lockstep over time, however low rates have distorted this relationship. The market is chugging higher while earnings are stagnant.

“For Q2 2016, the blended earnings decline for the S&P 500 is -3.2%. The second quarter marks the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009.” – Factset

According to Factset, this is the worst stretch for corporate earnings since the Great Recession. Yes, it was much worse then, but still...any comparison between now and then should give investors pause. Yet, that’s not the case as the chart below clearly demonstrates.

The divergence between weakening earnings and stock strength is growing. This is an unsustainable trend that will be either broken by huge earnings growth, or a market correction, or some combination of the two. Being generally constructive on the US economy, we do think earnings will improve. However, the days of dollar strength are numbered and how much earnings can improve for the larger companies is a real question.

Thus, going into September, we believe that investors are will soon start focusing on third quarter earnings. And, when they do so, they will be confronted by a very weak to negative trend in earnings growth. Combine this with stock valuations being very stretched and the market is set up for a pullback. The bottom line? September is historically the weakest month for the market and we think this September will prove no different.

Random Musings from Our Travels…

Late August has to be about the worst time for sports. Sandwiched between the Summer Olympics and the start of meaningful (why they play preseason is beyond us…) football games, there really isn’t much to enjoy. Sure, you have baseball, but that season never seems to end and around now it feels like a 3-mile horse race; instead of each move having meaning, baseball teams have been jockeying for position for so long you almost don’t care to watch until mid-September.

Since sports aren’t too interesting right now, what else is going on in the world that captures our attention? Well, there’s actually a Facebook page that is called “What’s Trending”. Maybe this is worth a view? I’ve listed the top stories; you can be the judge as to whether or not this is a good use of your computer time…

High school girl dresses like Mulan for her photo, it goes viral.

Britney Spears does carpool karaoke.

Go topless day is coinciding with the Ban the Burka movement in France.

Buzzfeed India aired a block of ice melting…for over an hour.

Taylor Swift took a photo of her cat sitting in an apartment window.

Need I go on? The list is long and it is truly amazingly boring. Thus, we eagerly await the return of football season and October baseball. Until then, enjoy the last of your summer and, if you’re feeling really hot and bored, check out the ice block melting.