Markets

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

Tom Lee, the co-founder of Fundstrat Global Advisors, has been one of the more reliable and reassuring voices of optimism during the current bull market, rarely if ever finding a proverbial wall of worry that was too high to be climbed.  

So naturally it caught our attention to hear that the strategist was nervous about what may happen in the stock market during August, a month that has tested the resolve of bulls almost like clockwork over the past few years. Don't worry, Lee fans, he hasn't turned into a bear yet: He's still expecting an 8 percent to 10 percent rise in the S&P 500 in the second half of the year. 

However, no one who is long the market should expect to get through next month without having to reach for the Tums.

Really, anyone who has been paying attention for the last few years will have most likely already stockpiled plenty of Tums in anticipation of the volatility we've come to expect. As quant guru Andrew Lo put it last year (using the technical jargon): "August sucks." 

Slow Month
August has featured an average drawdown of 6.1 percent during the past seven years of the bull market
Source: Bloomberg
Note: Shows biggest peak-to-trough S&P 500 declines for August during bull market.

Of course, once a trend is established long enough in the stock market to make investors start expecting it, that's approximately the time when they should begin to not expect it anymore. And the two ugliest Augusts shown above were the result of easily indentifiable catalysts --China's surprise currency devaluation last year, and the downgrade of the U.S. credit rating in 2011 -- rather than solely the effect of thin trading during a popular month for vacations, or some sort of other hard-to-identify seasonal voodoo.

Still, don't empty that Tums stockpile just yet. Besides the general bad track record for August, Lee adds two other observations that may make the coming month a source of heartburn once again. First, he looked at  the VXTLT -- an index of bond-market volatility -- and noticed it was one standard deviation higher than the VIX measure of stock-market volatility. Above-average bond volatility is a warning that there's a greater risk of a correction in that market, Lee pointed out. Stocks fell 68 percent of the time in the next month and averaged a decline of 1.3 percent when the bond market's volatility has been this much higher than the stock market's, according to Lee.

The other thing he examined was how the market performed the previous 13 times when the S&P 500 broke out to a record after a year or so of range-bound trading. While such a breakout is usually a bullish sign of more gains to come in the next year -- May 2007 was the only "head fake" of the 13 instances -- Lee notes that the following month was, on average, a flat one. So the fact that the S&P 500 has continued to set records suggests some proverbial "profit taking" may be ahead.  

Or maybe, you know, it's just simply that August sucks. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net