investment insights
September’s storm for stocks and the energy crisis
Lombard Odier Private Bank
Key takeaways
- September has historically been the worst month of the year for stock market returns
- This September looks particularly challenging, given energy and food price inflation
- Governments have diminishing ammunition to address these challenges as rate rises increase the cost of issuing new debt
- We are prudent in our portfolio construction and favour resilient, high-quality holdings.
The September Effect
September is typically an uneasy time for finance professionals. As days in the northern hemisphere become shorter and colder, there is a diffuse feeling of angst in markets, an apprehension that something may go wrong. This negative sentiment is backed up by historical data, which shows that September has been by far the worst performing month for the Dow Jones Industrial Average (DJIA) index since its creation in 1896 (see chart below).
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This phenomenon, dubbed the “September Effect”, is well known but poorly understood. One possible explanation is that households sell financial holdings to fund extra expenditure (tuition fees, new clothes and shoes) that piles up at the beginning of the school year. Another factor may be financial analysts being overly optimistic about stock market return expectations at the beginning of each year and downgrading their views in the autumn. Neither of these theories fully explains the phenomenon, which contributes to the nervousness: market participants know September is typically rough, but it is never clear from where the blows may fall.
Energy and food prices – an additional challenge
In addition to the factors cited above, the global economy faces several additional threats this autumn. A stark energy crisis is looming in Europe, where political solutions in many countries to date look inadequate to address the challenge. While energy spending represents around 10% of a European household’s budget on average, the energy crisis affects poorer countries and populations to a much greater extent. According to the International Monetary Fund, the poorest 20% of Estonian families, for example, may have to dedicate an additional 20% of their budget to honour energy bills this year. European relief schemes have yet to find a way to protect such vulnerable households.
Market data paints a stark picture (see chart below). The price of electricity to be delivered one year ahead has increased by more than 1200% in Germany and 1400% in France over the last twenty-four months.
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In the UK, energy bills are poised to rise 80% in October. Yet concrete measures proposed to support households would cover only a small proportion of the increase. Movements such as #dontpayUK (threatening mass non-payment of bills) are gaining momentum. Recent comments by Shell’s chief executive officer Ben Van Beurden highlight a gap between reassuring political statements and concerning market realities: “That this is going to be somehow easy or over is a fantasy we should put aside — we should confront the reality.”
Food inflation and shortages are a further concern. Covid-related supply chain disruptions and increasingly numerous climate shocks had already made for a tense food supply environment; the Ukraine war worsened the situation considerably. Russia and Ukraine represent around 70% of global sunflower oil exports, 30% of wheat and 20% of maize. According to the UN World Food Programme, the number of people facing acute food insecurity has risen from 135 million in 2019 to 345 million today. Soaring food and fuel prices have already fuelled protests in countries as diverse as Indonesia, Iran, Tunisia, Kenya and Peru. In Sri Lanka, they contributed to the government’s collapse in May. The longer the Ukraine conflict lasts, the more arable land falls out of production, further jeopardising future supplies.
Governments have diminishing ammunition
Meanwhile, emboldened by the ability to borrow at low or even negative rates, western governments have spent vast amounts of money to solve recent issues (e.g. tackling the European debt crisis, supporting incomes throughout the pandemic, boosting growth). This joker, so to speak, is no longer in the pack, as the cost of debt financing in most countries has skyrocketed in the past year.
As shown below, the yield on the 10-year Italian bond, for example, has risen more than fivefold over the last twelve months from 0.7% to 3.8%, putting a high interest price tag on any additional fiscal spending. One potential silver lining is that politicians may be pushed towards finding longer-term solutions (market or legislative reforms, new policies to help workers) to issues in the business environment, labour or energy markets, rather than relying on short-term borrowing. Alas, the former typically take much longer to implement and bear fruit.
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Tragically, the price increases we are witnessing in energy, food, fertilisers and fuel threaten to cause not only equity market volatility and further drawdowns, but also increased levels of bankruptcies and social unrest. The flipside of the western plan to punish Russian aggression in Ukraine involves imposing considerable hardship on domestic firms and households in the coming years.
Favour resilient, high-quality holdings across asset classes
Against this uncertain backdrop – and with markets facing the potential for further downside ahead – our portfolio positioning is prudent, with a focus on high-quality holdings across all asset classes to increase portfolio resilience. We maintain a cautious stance towards equities, favouring firms that look capable of preserving their margins and withstanding lower economic growth. We also retain hedging strategies on stock indices to help shield portfolios from downside risks. In fixed income, we have reduced our allocation to government bonds, and are now underweight. Specifically, we have reduced our exposure to Italian and Brazilian debt, ahead of elections in September and October respectively. The proceeds of these divestments are held in cash for now, giving us the flexibility to react quickly to future opportunities, wherever they may arise.
Important information
This is a marketing communication issued by Bank Lombard Odier & Co Ltd (hereinafter “Lombard Odier”).
It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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