September — “A Peculiarly Dangerous Month”

“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

Even as the U.S. and European stock markets hit five-month highs in August, many investors are getting nervous. By most technical measures, the market is overbought and due for a correction. At the same time, “Sell in May and Go Away” has not turned out so far to be great advice this year. Global stock markets have been in “stealth” rally mode since June 4 when European Central Bank (ECB) boss Mario Draghi promised to do “whatever it takes” to save the euro.

Meanwhile, there are several key events in the weeks ahead whose outcome could impact profoundly what happens in global stock markets this September. Traders anxiously are awaiting Ben Bernanke’s keynote speech at the annual central bankers meeting in Jackson Hole, Wyo., on Friday to see whether quantitative easing part III (QE3) is on the way. And on Sept. 6, the ECB will decide whether to step in to buy government bonds, mimicking the Fed and Bank of England’s QE strategy.

A Peculiarly Dangerous Month: A Grim History

October has a particularly bad reputation among investors as a bad month for stocks. Yet, Mark Twain’s famous quip notwithstanding, September is the month that has cost investors the most money over time.

The U.S. stock market has an unsettled history during the month of September. Lehman Brothers collapsed in September 2008, bringing 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 1998 financial crisis began in late August, it was in September that super hedge fund Long Term Capital Management collapsed, which Bill Clinton (quaintly) called “the greatest financial crisis since the Great Depression.”

But September’s weakness stretches back farther into the past. The crash of 1987 may have happened in October, but the market began its descent right around Labor Day. And although the crash of 1929 is commonly associated with October, the market peaked just around this time of the year. The worst month of the Great Depression? That took place in September 1931, when the Dow fell a whopping 30%.

Since 1926, September is the only month of the year with an overall negative average return in U.S. markets. In every other month, investors have averaged a 1% gain. Equally importantly, the September anomaly holds true not only 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 the markets examined, investors lost money in September in 15 of them.

A Peculiarly Dangerous Month: The Bears Roar

The “glass half empty” crowd can marshal a lot of data to argue that September 2012 is set to live up to its grim reputation. After all, the U.S. market rally over the last few months has been on very low volume. Formerly red-hot emerging markets have yet to recover their May highs. A worse-than-expected ECB announcement on Sept. 6 would send bond yields for Spain and Italy soaring, as well as raise new questions about the sustainability of the euro. Chinese growth grinding to a halt is already impacting Asian economies, and could negatively impact U.S. multinationals like GM, Ford, and Yum! Brands, and, by extension, Wall Street. Commodity prices already have been hit hard by a drop in Chinese demand. Throw in the threat of a “fiscal cliff” in the United States — looming tax increases in 2013, combined with automatic spending cuts, and it’s no wonder that David Kostin of Goldman Sachs recently sent a note to clients warning that the S&P 500 will fall to 1,250 by year’s end.

A Peculiarly Dangerous Month: Your Strategy?

Why markets do so poorly in September is one of the great mysteries of stock market history. Some even blame seasonal affective disorder. Investors simply get grumpy and sell just as the days get shorter.

Yet for all of its apparent predictability, there’s not that much you can, or even should, do. For one thing, no stock market pattern is written in stone. The U.S, stock market actually jumped in four out of the last six years, in September of 2006, 2007, 2009, 2010. And unless markets completely fall out of bed, the transaction costs of selling before the end of August and re-entering the market a month later are not worth it.

Here’s why I am optimistic about markets once they get over the September hump. The recent rally in global stock markets has not been driven by optimism, but by a reduction of pessimism. This highlights one of the most counterintuitive rules of stock market behavior you’ll ever hear: the future doesn’t have to look bright for stock markets to do well. The future simply has to look better than the present. I also believe that the improving prospects of a more business-friendly Romney victory in the U.S. elections also could go far in improving the markets’ animal spirits.

So, view the current negativity in global markets as a welcome sign. It lowers expectations. And it’s when low expectations are beaten that markets really break out on the upside. After September’s bout of nervousness, get ready to pile back into global stock markets for what I expect to be a very strong fourth quarter.

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru