(Bloomberg) -- On August 24th of last year, the Dow dropped 1,000 points intraday to end down 588 points, and the S&P 500 Index fell into official correction mode. After that, we suffered through January's stock market turmoil and then got whacked with Brexit.
Can we please hit the beach now?
We can, but while we do, stocks might hit the skids. A measure of volatility for bonds has moved significantly higher than volatility in equities, and that suggests that U.S. stocks are poised to fall in the next month, according to a report by Thomas Lee, managing partner at Fundstrat Global Advisors LLC.
If you've been practicing good financial habits, a well-diversified portfolio may lessen any potential pain. Traditional havens are more expensive than they were last August, an extra reason to ignore market swings, assuming you're comfortable with your equity stake. Lee and other strategists expect turmoil in August to be a pause in a continuing bull market.
Alternatively, you may want to re-examine your definition of risk and consider a move into underperforming asset classes. More on that in a moment.
Lee's analysis of the market shows that over the past 12 years, in the 20 trading days after a volatility gap like the one he sees now, the S&P 500 declined 68 percent of the time, with an average loss of 1.3 percent.
A longer look at historical stock market numbers for August shows that 1.3 percent might be a best-case scenario. More than a third of the time, going back to 1945, price drops of 5 percent or more in the S&P 500 have been in either August or September, noted Sam Stovall, U.S. equity strategist for S&P Global Market Intelligence, as he shows in the chart below.
Why are the two months so bumpy? A lot of it may be tied to capital flows. Pension funds tend to add to their holdings in the beginning of the year, 401(k)s tend to be maxed out early in the year, IRAs have to be funded by April 15, and if you get a refund check back from Uncle Sam, you file early and possibly put some of that money back into the markets, said Stovall.
The month-by-month table below tells the seasonal tale. August has the fourth-worst record for positive months, with 54 percent of Augusts ending with a gain. June and February are slightly worse, at 52 percent, and September takes the rancid cake, turning out a positive return only 43 percent of the time. On the performance front, only October's worst-ever monthly showing of a 21 percent drop tops the 14.6 loss for August and the 11.9 percent for September. And October was still a positive month 61 percent of the time.
For investors, forewarned is forearmed. If you're aware that the next few months may be volatile, then maybe you won't make an emotional decision and be tempted to sell at or near a bottom. It also provides a good excuse for making sure you're still comfortable with your equity asset allocation, and thinking hard about how you'd react if, say, your portfolio lost $50,000 over a narrow window of time. In any case, retreating into the perceived comfort of U.S. government bonds will yield less now. Last August, the yield on the 10-year Treasury was about 2 percent. Today, its popularity has driven its yield down to around 1.6 percent.
For undervalued asset classes to invest in, the suggestions of a panel of experts in Bloomberg's Where to Invest $10,000 Right Now in late June are still pertinent today. They highlight the strategy of targeting underperforming asset classes ripe to return to their historic levels, including emerging-market value stocks. The move back toward a historic norm seems to have started already, though, so emerging-market index funds and exchange-traded funds aren't as cheap as they were a few months ago.
Stovall sees a way to cope with volatility beyond grimly powering through it, or venturing into unloved asset classes. His research found that if you separate stock market performance from 1990 until now into six-month chunks, from May to October, and from November to April, you find that the market was up 1.5 percent on average from May to October but up 7 percent from November to April. Two sectors bucked the May-to-October trend: consumer staples and health care.
"When the going gets tough, the tough go out eating, smoking, and drinking, and then they have to go to the doctor," said Stovall. You can see the frequency of outperformance (F.O.) in those sectors in Stovall's table below.
You can play that seasonal pattern by owning the S&P 500 Index ETF (SPY) from November to April, but at the end of April moving half the money into a consumer staples ETF and half into a health care ETF. At the end of October, move back into SPY. Rinse and repeat.
"You'd have added almost 400 basis points [4 percentage points] a year to your portfolio return while reducing volatility," he said, and the strategy works across market-cap size and across regions.
Another seasonal strategy: Slather on some more sun screen, curl your toes in the sand and get lost in a good book.
To contact the author of this story: Suzanne Woolley in New York at [email protected] To contact the editor responsible for this story: Peter Jeffrey at [email protected]