MARKET OVERVIEW: September's Messy Market Setup

September kicked off with its typical messy baggage, coming off five straight months of gains, including a 2.4% jump in August that marked the best performance since 2021. The S&P dropped 0.7% on its very first trading day of September. Now, there were a lot of factors, but higher oil prices and rising long-term Treasury yields really did the damage to the S&P. Another important point is that one bad day doesn't make a trend; however, it does set up the real question for the month: Are we looking at the standard calendar noise that September often brings, or will the combination of a midterm election and a hawkish Federal Reserve turn this month into a real grind?

The History Is Real, but It Isn't a Guarantee

The historical map for September is notoriously ugly. Since 1928, the S&P 500 has dropped an average of 1.2% during the month, making it the worst period of the year. Stocks finish lower 55% of the time, and nine of the 40 worst monthly selloffs on record have happened in September. These poor numbers are certainly noteworthy, but perhaps there’s a silver lining. A few really bad market crashes pull that average down heavily, and about 45% of the time, stocks do manage to rally in September. Seasonality tells us how risks are weighted, but it doesn't dictate the exact closing price. The weakness usually comes down to simple mechanics: institutional repositioning, tax selling, and the reality check that happens when summer narratives collide with cold, slow autumn data.

The Midterm Drag

Midterm election years traditionally drag down the broader four-year presidential cycle. Since 1931, the S&P has averaged a 4.7% gain in midterm years, compared with the 9.5% average seen in most other years. Volatility also spikes, with the median VIX hitting nearly 16% in September during these midterm drags, compared with the usual 13%. Since 1970, September has felt this weight directly. Since World War II, the numbers show about a 1.3% average decline in midterm Septembers, according to Bespoke Investment. That is nearly double the 0.7% drop seen across all other years in September. The main issue isn't just that stocks go down; it's that the market also gets incredibly nervous or jumpy. An election makes traders try to price in shifting scenarios for the new government that may be coming, including taxes, government spending, and regulations. The political premium, or volatility, climbs even if Wall Street doesn't heavily favor the Democratic Party over the Republican Party. Politics simply amplifies the chaos.

The Problem Now: The Fed Might Hike

Another problem facing the market right now, maybe more than anything else, is that the Fed is likely to hike rates. In July, the Federal Reserve kept interest rates steady at 3.5% to 3.75%, but there was dissension: three voting members wanted to increase rates by a quarter of a point. The Fed's preferred inflation gauge, core PCE, is stuck at 3.7%. This is well above the official 2% target rate that Fed Chair Warsh has been very adamant is their primary objective. CME data currently shows the probability of a September rate hike at 66%, a distinct jump from the 35% probability priced in before the Federal Reserve chairman's statement in Jackson Hole last week. I believe the concern that the market is trying to price in right now is that this isn't a minor tail risk anymore. Will this turn into a cycle or a prolonged tightening campaign rather than a one-off, single rate hike? This market pricing is being reflected in global bond yields, as the 10-year U.S. Treasury yield has climbed to 4.8%, a level that typically starts to put pressure on the S&P 500.

A Confluence of Risk

Seasonality, elections, and monetary policy are not necessarily isolated events. They're actually three overlapping threats hitting the market simultaneously right now. September already has a historically fragile backdrop, the election widens the range of policy outcomes and uncertainty coming out of D.C., and an aggressive Fed resets the discount rate used to value those very outcomes.

Relief on the Horizon

The good news is that, historically, the math improves dramatically once the election occurs. Data from U.S. Bank reveals an average 12.4% market gain in the 12 months following a midterm election. The election itself doesn't spark the rally. Rather, by November, investors finally get clarity on inflation trends, Fed policy, and corporate earnings. A rough September and a strong winter recovery can both happen.

Some key things to monitor in the options market include:

Volatility term structure: Look at whether options pricing is clustering risk around inflation releases, the upcoming Fed meeting, or Election Day itself.

Downside skew: Check whether institutional demand for protective puts is climbing even while the headline VIX stays quiet.

Yields versus multiples: Track whether rising Treasury yields are forcing a market-wide repricing or whether they're just hitting specific speculative sectors.

Earnings revisions: watch for analysts cutting profit targets in the exact sectors where valuation multiples are shrinking.

Sector group divergence: Watch how rate-sensitive and policy-sensitive groups trade relative to the broader index.

Seasonality isn't a flawless directional roadmap. Treat this September as an explicit risk regime rather than a definitive prophecy.