'Fast Money' traders look ahead to September market setup

Key Concepts

• Record Highs: Recent achievements in market indices.
• Sell-off: A rapid decline in asset prices.
• Rate Cut: Reduction in the central bank's key interest rate.
• Basis Points: A unit of measure used in finance, equal to 0.01%
• Small Cap Stocks: Stocks of companies with a relatively small market capitalization.
• Russell 2000: A stock market index that represents the smallest 2000 companies in the Russell 3000 Index.
• Earnings Growth: The increase in a company's profits over a period of time.
• Cyclical Value Stocks: Stocks of companies whose performance is closely tied to the economic cycle and are considered undervalued.
• Tariff Fallout: Negative economic consequences resulting from tariffs.
• Passive Investing: An investment strategy that involves tracking a market index.
• S&P 500: A stock market index that represents the performance of 500 of the largest publicly traded companies in the United States.
• VIX: A real-time market index representing the market's expectations for volatility over the coming 30 days.
• FOMC: Federal Open Market Committee, the policy-making body of the Federal Reserve System.

Market Performance and Historical Context

• Recent Market Performance: The market experienced record highs recently, followed by a slight decline.
• Historical Bounce Back: The market demonstrated a historically fast recovery from a sell-off in April.
• Market Cycles: Bull and bear markets are collapsing on each other, cycling through quickly.
• September Weakness: Anticipation of temporary market weakness in September, lasting approximately two weeks.
• Historical September Performance: Historically, the S&P 500 has fallen about 1.1% in September.
• Year-End Rally: Generally, there is a rally heading into the new year.

Rate Cut and Market Expectations

• Importance of Rate Cut: The decision on a rate cut by the Federal Reserve is crucial for the market.
• Hedged Bets: Investors are hedging their bets, anticipating a potential 25 basis point rate cut instead of the previously expected 50 basis points.
• Late October Rebound: Expectation of the market getting back on track in late October, contingent on the rate cut.

Small Cap Stocks and the Russell 2000

• Russell 2000 Underperformance: The Russell 2000 has not reached its previous high from last November.
• Justification for Underperformance: The underperformance is justified by the lack of earnings growth in the index.
• Non-Earning Companies: 40% of the Russell 2000 index consists of non-earning companies.
• Rotation to Value: A rotation towards cyclical value stocks is observed, driven by reduced concerns about tariff fallout.
• Passive Investing Outflow: The outflow from passive investing in small caps could happen very quickly, mirroring the rapid inflow in August.

Volatility and Market Sentiment

• VIX Level: The VIX is at 14, indicating low fear or options volatility.
• September Volatility: September is historically a slightly above-average month for volatility.
• October Volatility: October is historically an even more volatile month.
• Disproportionate Effect of Pullbacks: Market pullbacks and increases in volatility have a disproportionate effect on averages.
• Average S&P Return: The average return for the S&P is approximately 60 basis points over the long term, with significantly higher returns more recently.

External Factors and Future Outlook

• Labor Day Weekend: The current market weakness is occurring on a thin trading day before a three-day weekend.
• Post-Labor Day Focus: Greater interest in market activity after Labor Day.
• FOMC Impact: The FOMC meeting in September is a key event to watch.
• Tariff Situation: The tariff situation remains cloudy and is a factor influencing market sentiment.

Synthesis/Conclusion

The market is currently in a state of anticipation, with a focus on the upcoming FOMC meeting and the potential for a rate cut. While historical data suggests a potentially weak September, the overall outlook remains positive, contingent on the Federal Reserve's actions. Small cap stocks, particularly the Russell 2000, have been underperforming due to a lack of earnings growth, but a rotation towards value stocks is underway. Market volatility is expected to increase in September and October, but the long-term average return for the S&P 500 remains positive.