Don’t Be Scared of the ‘September Effect’

SUMMARY

• September has historically been the most difficult month for US stocks.
• However, September’s troubles have historically been followed by stronger markets through the new year.
• Our current fundamental and technical read on the market this autumn remains constructive.

We've received many client questions about seasonality in stocks, and specifically about the 'September Effect'. This is the theory that investors should sell their stocks after Labor Day to avoid autumn volatility. September does appear to be a statistical anomaly, as it is by far the worst month for stock returns over the past century (see Chart 1 below, courtesy of NDR Research). However, we do not believe investors should sell indiscriminately just because of this heuristic.

Several theories attempt to explain September's historical underperformance. One idea is that institutional investors return from vacation and begin "window dressing," or selling underperforming stocks before year-end reporting. The September/October period also tends to be an information vacuum after second quarter earnings season. This void is often filled with ‘FUD’ (fear, uncertainty, and doubt). Investors have plenty of FUD this year, with concerns around the economic impact of tariffs and Fed policy.

So, if September is truly an anomaly, why not simply exploit it by selling? Because trying to ‘time' the stock market is often an exercise in futility, in our view. In September, stocks were still up almost half the time since 1925, rendering the 'September Effect' practically a coin flip. Selling in the fall could leave investors vulnerable to getting 'whipsawed' by significant market rebounds, particularly since October often marks significant market bottoms and returns from November through January tend to be stronger than average. Furthermore, timing strategies could lead to higher portfolio turnover and potential for trade errors, as well as a more complicated, stressful process for investors.

Time in the Market… Not Timing the Market

We subscribe to the old saying, "investment success isn't in timing the market... but rather time IN the market." Staying invested, even when (or especially when) things seem scary, tends to be the best long-term strategy in our view. Historically, after peak-to-trough drawdowns of over -20% (i.e., bear markets), stocks have usually been significantly higher twelve months later, by an average of double digits (see highlighted green bars on Chart 2, below). This suggests to us that an investor’s biggest mistake is NOT failing to avoid a downdraft… but rather, failing to participate in the subsequent upside recovery. For these reasons, we believe using simple heuristics like the 'September Effect' are fraught with peril and should be approached with trepidation.

Conclusion: We View Market Fundamentals and Technicals as Constructive, Outweighing the ‘September Effect’

Regardless of the volatile nature of autumn, not all Septembers are created equal. As we have laid out in recent Weekly Views, we view the US economy as remaining on track, Fed independence should be maintained, and we expect some rate cuts between now and the end of the year. All of this creates a backdrop generally conducive to further stock gains through year end, in our view. We also believe that US ‘Economic Exceptionalism’ is not dead, as corporate America has adjusted well to the headwinds that have appeared this year, posting strong earnings growth year-over-year in the second quarter.

The technical backdrop of the US stock market is supportive of further appreciation in our opinion. As we wrote about in our last ‘3 Rules’ Weekly View, the trend on the S&P 500, which we define as the 200-day moving average (DMA), has perked up as the technology sector has led the index to set a series of new all-time highs. Currently, the trend is rising at a 14% annualized rate; if history is any guide, we believe this condition should bode well for stock returns over the next 3 to 6 months, even with investor sentiment near optimistic extremes.

This optimism is reflected across our balanced portfolios, as the portfolios are currently overweight US stock exposure. Given the volatile nature of September, we are watching both fundamentals and technical levels closely, and will act if our risk management processes deem it necessary. However, we will approach such decisions with the appropriate level of humility about our (or anyone’s) ability to perfectly time these tactical moves…and as always, we will also formulate a reinvestment plan concurrent to any risk reduction plan implemented.

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.