SmartInMoney

 

 

 

Investors are cautious as stock markets are entering their seasonal, puzzling September. It has been known that September is historically the worst month for stocks. Lehman collapse in September last year is still fresh in investors’ memory. The collapse dragged the world stock markets down to their lowest point in March 2009, a level not seen in the past decade.

 

Bullish mood in the past five months has spread over the globe. The U.S. stock markets shot up above 40% from their March low as they cheer up improving economic news. Home sales in July jumped 9.6% for newly built single-family homes and 7.2% for existing homes. The S&P/Case-Shiller U.S. National Home Price Index rose in the second quarter from the previous quarter, the first time in the past three years. Real operating earnings at big U.S. companies have climbed back to levels first hit in 1998 and the majority of S&P 500 companies have surpassed earnings targets.

 

Entering the September, there is a puzzle whether the stock market will continue its upward momentum or will fall to follow the seasonal pattern of the September effect anomaly. According to the efficient market hypothesis (EMH), the stock return should not be predictable and thus, the behavior of the stock returns inconsistent with the EMH is considered an “anomaly”.

 

Economists express their worry about a double-dip recession, while some analysts think the stock market is excessively exuberant. They believe that there are a number of problems that will loom heavier. The unemployment is heading 10% through next year and the federal budget deficits are expected to increase to $9 trillion over the next decade. While corporate bond issuance is running well, the all bank loan and leases have declined at the record of annual rate of 8%. Therefore a poor stock market return in September is not out of the question.

 

Research

Jeremy J. Siegel in his book “Stocks for the Long Run” shows that September is by far the worst moth of the year. Dow Jones Industrials has an average negative return of 1% for the period of 1885 to 2006. Furthermore, the September effect has not only prevailed until recently, but it has actually been stronger since 1990 with an average negative return of 1.5% from 1990 to 2006 (see chart below).

 

 

 

An investment of $1 in DJIA in 1885 would be worth $490 by the end of 2006 (dividend excluded). In contrast, $1 invested in the Dow only in the month of September would be worth only 23 cents. On the other hand, if you put your money in the stock market every month except September, your dollar would have been worth $2.176 at the end of 2006 (see chart below).

 

 

 

 

The poor returns in September also prevail in the rest of the world. September is the only month of the year that has negative returns in a value-weighted index. September has been the worst month in 17 of the 20 countries analyzed and all the major world indexes, including the EAFE Index and the Morgan Stanley all world index.

 

A dissertation presented by Hyung-Suk Choi from Georgia Institute of Technology in December 2008 mentions that the U.S. stock market return in September was negative 0.24 % over the last two hundred years, and it is the only month with the negative mean return. The September average return is significantly negative in 15 out of 18 developed countries over the whole sample period, which varies from 38 years to 208 years upon data availability. Moreover, the September return is negative in all 18 countries over the period 1970 to 2007.

 

Hyung-Suk Choi suggested that exiting the stock market in September would provide considerable benefit to investors. The strategy yields higher mean return and lower standard deviation than the buy-and-hold strategy. The Sharpe ratio of the strategy is also greater than that of the buy-and-hold strategy.

 

If an investor put $1 into the US stock market according to the buy-and hold strategy at the beginning of 1927, she would have $2,363 at the end of 2007. However, she would triple the wealth up to $6,784 at the end of 2007 if she exit the stock markets at the end of August and reenter at the end of September (see chart below).

 

 

 

Possible causes of a September effect

Experts have offered some theories to explain possible causes of September effect.

• Mutual funds drive down the market by selling their losing stocks before their October 31 year end.
• Third quarter profit warnings come in early September, raising fears about full-year results.
• Seasonal affective disorder premise explains that investors simply get more risk-averse, and more prone to sell, as  the days get shorter in September.

Strategy

A relevant question now is what investors should do in this September. In general, timing the stock market is not a good strategy. Some approaches may be taken in order to avoid the September effect anomaly.

 

Small, risk-averse investors may take a pause from putting more money into the stock market during the September.

 

Long term investors may adopt September effect strategy suggested by Jeremy J. Siegel and Hyung-Suk Choi by selling off their position at the end of August and coming back in the early October. This strategy is justifiable if large amount of money involve and time horizon is long; otherwise the transaction costs will offset its potential benefit.

 

Investors may take this seasonal pattern as an opportunity to rebalance their portfolio. The rebalancing involves reducing relatively over-value asset class in the late of August and adding the undervalued asset class in the early of October.