Morgan Stanley anticipates a decline in the US equity market in Q3, expecting a decrease of up to 10%. The firm attributes this to tariffs affecting both consumers and corporate balance sheets.
Recent data shows an increase in inflation, slowing job growth, and a drop in consumer spending. Historically, August and September have seen seasonal weakness, with the S&P 500 averaging a 0.7% loss in each month compared to a 1.1% gain at other times.
Stocks Are Overpriced
Stocks are reported as overpriced, with the S&P 500’s 14-day relative strength index peaking at 76. This suggests a risk of potential market overheating.
We are looking at a potential 10% pullback in the US equity market this quarter. The latest Consumer Price Index for July 2025 came in at 3.8%, above expectations, and the recent jobs report showed a disappointing 150,000 new jobs, fueling concerns. These factors suggest we should position for a downward move.
Given this outlook, we believe purchasing put options on broad market indices like the SPY or QQQ is a prudent strategy. This allows for direct gains if the market declines as anticipated. It’s a way to hedge existing long positions or speculate on the downside.
Market volatility, as measured by the VIX, is currently sitting near a low of 13, indicating a high degree of complacency among investors. Buying VIX call options offers an effective way to capitalize on the fear that would accompany a sharp market sell-off. We saw the VIX spike from 14 to over 26 during the market turbulence in the fall of 2023, showing how quickly sentiment can shift.
Technical Indicators And Seasonal Weakness
With the S&P 500’s 14-day relative strength index recently peaking at 76, the market is technically overbought. This presents an opportunity to sell out-of-the-money call credit spreads on indices or overvalued individual stocks. This strategy generates income and profits if the underlying asset trades sideways or moves lower.
We must also consider the historical seasonal weakness associated with August and September. On average, the S&P 500 has posted losses in these months, a pattern we observed as recently as September 2023’s 4.9% decline. This historical precedent strengthens the case for adopting defensive derivative positions now, ahead of this historically challenging period.
