Is a “September Swoon” in the Cards?

“October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”

–Mark Twain

As the summer draws to a close and traders return to their desks today, the mood in the financial markets is as nervous as ever.

Sure, the S&P 500 just closed its strongest month since February, climbing over 4% in August. Yet, there were few signs of celebration when it closed above 2,000 for the first time, 16 years after it first breached the 1,000 level. Indeed, rarely has a new major high in the U.S. market been greeted with greater skepticism.

Emerging markets have done even better, rallying 6% since the start of June.

But you wouldn’t know it from reading the headlines. Facing a potential full-scale war in Ukraine and in the midst of another Middle Eastern crisis, market sentiment is still firmly rooted in fear. The “doom and gloom” crowd is already predicting that September 2014 will mark the start of another massive market drop. The ever-attention-grabbing Harry Dent has already predicted that the Dow is set to drop all the way to 6,000 — though we’ll have to wait for that until 2016.

September Swoon: A Grim History

October has a particularly bad reputation among investors as a bad month for stocks. Mark Twain’s famous quip notwithstanding, September — and not October — has been always the lousiest month for investors.

Since 1926, September is the only month of the year with an overall negative average return in U.S. markets. More recently, since 1950, September has seen an average decline in the Dow of 1.1%. The Nasdaq also has fallen an average of 1% during September since it was established in 1971.

Nor does the September anomaly only hold true for the United States. A Georgia Tech study looked at data for 18 developed stock markets around the world going back as far as 200 years. Among all the markets examined, investors lost money in September in 15 of them.

But it’s not the statistics that account for September’s fearsome reputation.

It’s the drama that always seems to occur around this time of the year.

The crash of 1987 may have happened in October, but the market peaked right around Labor Day. And although the crash of 1929 is commonly associated with October, the market hit its highs just around this time of the year.

And what was the worst month of the Great Depression? September 1931, when the Dow fell a whopping 30%.

More recently, it was six years ago in September 2008 that Lehman Brothers collapsed and brought the entire global financial system to its knees. And it also was in September 2000 that the post-dot-com bubble collapse accelerated. Two years later, in September-October 2002, the bear market hit its lows. And although the Russian government defaulted on its debt in August, 1998, it was in September that hedge fund Long Term Capital Management collapsed. Quaintly, Bill Clinton called that crisis “the greatest financial crisis since the Great Depression.”

September Swoon: What is to Be Done?

Why markets fare so poorly in September is one of the great mysteries of stock market history. Some pundits have tried to pin the blame on mutual fund managers who sell losing positions before the end of their fiscal year. Others dig deeper and blame the lack of sunshine causing seasonal affective disorder. Investors — at least those in the Northern hemisphere — get grumpy and sell just as the days get shorter.

Yet for all of the apparent predictability of the market, there’s not that much you can, or even should, do about any September Swoon.

First, the transaction costs of selling today and re-entering the market a month later are not worth it.

Second, no stock market pattern is written in stone. Dig deeper into September’s history and you find that isn’t so bad if the Dow is up in the previous eight months, as it has been this year.

What matters more is what the market will do after September.

You’d have to search long and hard to find anyone who’d argue that the recent rally in global stock markets has been driven by optimism. Investors are as skeptical as ever. And experience has proven that it’s when market sentiment is most negative that the markets really break out on the upside.

That’s why looking ahead, I am optimistic about markets once investors get over the current bout of fashionable pessimism.

So, view the impending negativity in September as a positive.

After September’s bout of nervousness, get ready to pile back into global stock markets for what I expect to be a traditionally strong fourth quarter.

In case you missed it, I encourage you to read my e-letter column from last week about why 2014 has been another lousy year for hedge funds. I also invite you to comment in the space provided below.