September could be the cruellest month for stocks

Bonds and gold are telling us one thing. Shares seem to still be saying the opposite. It’s natural to think they can’t all be right. And as we head into the most dangerous stretch in the market year, there’s a string of key announcements over the next fortnight which could decide whether it’s the fixed income pessimists, the precious metal catastrophists or the rose-tinted equity bulls who have their finger on the pulse.

First, the good news. After April’s liberation day wobble, shares have enjoyed a remarkable bounce over the summer. If you sensibly ignored the old adage about selling in May and going away until St Leger’s Day, congratulate yourself. The Doncaster horse race that marks the end of that often-unhelpful advice is run next Saturday. Bar some kind of market calamity, 2025 will be one of Sell in May’s most epic fails.

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Since Donald Trump’s U-turn on tariffs, just a week after he unveiled them at the beginning of April, the S&P 500 and our FTSE 100 have risen by around a fifth. The Nikkei 225 in Japan is up by a third. You would not have wanted to be out of the market this summer.

Equity market momentum has been driven by a rare combination of tailwinds. Second quarter earnings season was surprisingly strong, the US consumer is holding up much better than expected, companies are learning to live with tariffs, investors have a guiding narrative in AI, and the Fed is about to cut interest rates. Until something happens to alter that positive narrative, few are willing to believe the equity glass is anything but half full. It is why volatility is suspiciously low and hedge funds ramped up their buying in August.

But the next two weeks will test some of those assumptions. This week’s jobs report in America will be a crucial test of both the growth and the interest rate stories. Unfortunately, they can’t both be positive. If the labour market weakens, that will cement the case for an interest rate cut on the 17^th of the month but at the cost of an economic slowdown. More jobs than expected sounds better, but it will unsettle a market that’s convinced borrowing costs are on the way down.

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Next week, the spotlight shifts to inflation and that will be the focus for nervous bond investors. Unlike their equity counterparts, they prefer to see the cloud surrounding the silver lining. For a sense of their pessimism, you need only look at the yield on the 30-year government bonds issued on either side of the Atlantic. These are the long-dated issues that are most sensitive to inflation fears, concerns about fiscal sustainability and the balance of supply and demand.

Bond investors are insisting on a higher return on their investments to compensate for what they perceive to be heightened risks. Here in the UK, long bonds are yielding more than at any point since the late 1990s - around 5.7%. In the US they offer a compelling 5%. And in chaotic France, the 4.5% yield on the long bond stands at a 14-year high, a level not reached since the Eurozone debt crisis.

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Top of the list of concerns is the sheer scale of debt outstanding in the developed world. That and the expectation that it will only get worse in future. In the US, the continuing fiscal splurge is expected to add $3trn to national borrowing by 2034, increasing the debt to GDP ratio from 100% to 124% over that period. In Europe, higher defence spending is the trigger - more than €1trn over ten years. Here, low growth and a reluctance to live within our means is to blame.

Increased demands on public spending are coming at a time when there are no longer price-insensitive buyers in the global bond market. Central banks are unwinding their quantitative easing programmes while pension funds are running down the final salary schemes that traditionally lapped up the supply of long bonds to match their long liabilities.

Meanwhile, the politicisation of monetary policy in the US, alongside tariffs and immigration curbs, makes it unlikely that inflation will stay in check over there. Here, price rises are running at twice the Bank of England’s target. It’s little wonder bond yields stand at a multi-decade high.

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All of this bad news is catnip to gold bugs. In fact, fiscal dominance - low interest rates today paid for by higher inflation tomorrow - is the perfect backdrop for the safe-haven precious metal. For an inflation hedge that pays no income, and so benefits from low interest rates, what’s not to like about a neutered US central bank. Both gold and silver have doubled in three years. Gold stands at a new all-time high above $3,500.

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September can be the cruellest month for investors. According to Bank of America, the S&P 500 has fallen 56% of the time in September. In the first year of a Presidency, the odds are slightly worse, and the average fall slightly greater. Since 1927, September is the only month of the year with an average decline (February and May are flat and the other months positive). After four consecutive months of gains, with valuations looking stretched again, the odds of a stock market stumble this month cannot be dismissed.

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So, it feels like bonds and gold are more firmly grounded in reality than shares right now. Which is not the same thing as predicting a correction. Investors can hold onto conflicting messages at the same time for longer than seems rational. 
The bond and gold markets can fret about bad policy long before it gets in the way of a continuing equity bull market that’s underpinned by earnings growth and a genuine technological revolution. If inflation is the outcome, and I think this is inevitable, it seems logical to favour shares and gold over bonds and cash.  Exuberant, yes; irrational, maybe not yet.

This article was originally published in The Telegraph.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of financial adviser or an authorised financial adviser of your choice.