Get ready for an action-packed September in stock markets!

Equity fund managers around the world must have been breathing a deep sigh of relief as a strong rally in equity markets in the last week of August erased half of their potential loss for the month.

The rally was stronger in the US compared to Europe, which was essentially justified by the macro data. Indeed, as the below chart shows, whilst the Citigroup Economic Surprise Index in Europe continues to sink ever deeper, the US equivalent index continues to rebound relatively strongly:

Economic Surprise Index for the US (white – LH scale) and Europe (red – RH scale) – source Bloomberg

Of course, the “wink-wink” from Ben Bernanke to financial markets at Jackson Hole and the subsequent media campaign orchestrated by the Fed around the “easing theme” helped tremendously.

Yet, whilst equity markets around the world seemed to be painting a more benign picture by month end, the bond, currency and money markets are currently sounding the emergency horn. Indeed, the flight to quality into German bunds and the sell-off of Euros across the board has been the theme since the 1st September whilst tensions in the USD funding for European financial institutions seem to resurface.

The news that the independent Greek State Budget Office confirmed that the Greek government had exceeded its primary deficit target for 2011 after only seven months sets the tone for an action-packed September:

Add to that the back-tracking of the Italian government on their austerity plan and you get the idea that the inferno of the Euro-zone sovereign debt crisis is still bubbling…

Hence September, historically the worst performing month of the year for US stocks, promises to be another volatile one! This is clearly a trader’s market and you need to remember that if you get involved. Relative plays may be a better idea in this context.

Looking at the restrictions currently in place with regards to short selling in Europe, it is clear that DAX has become the proxy for short selling the Euro-zone since the inception of short selling bans in France, Italy, Spain and Belgium, contributing to a sharp underperformance of the index versus its main European peers over the period:

Relative performance of CAC, DAX and Euro Stoxx 50 – source Bloomberg

This underperformance may well continue to be the play going into next week!

With regards to absolute levels on a weekly perspective, we would only consider getting involved on the long side at the extreme, playing on another installment of the “Bernanke Put” to be potentially delivered at the next Fed meeting on the 21st September.

For DAX, this might mean scaling into longs in the 5,500 to 5,350 area. We would consider off-loading into the bracket 5,750-5,900 and fade strength towards 6,000. Should we see a weekly close above 5,600, the range between 5,600 and 5,800 may be the play in the early part of the coming week.

DAX Index – daily chart – source: Bloomberg

For the S&P 500, the index looks toppish short term after its strong performance towards month-end. A weekly close below the 1,200 mark should open the way for more consolidation (note that US markets are closed Monday for Labor Day). Hence we might get involved from the long side between 1,130 and 1,100.

The 1,235 to 1,250 area looks like a daunting resistance area for next week so we would fade strength in that zone should we see unexpectedly strong upside.

Safe trading!