In recent days, a number of market watchers have issued warnings about economic data and events that could roil markets this September. Investors might also want to consider an additional headwind: The seasonal pattern of equity market weakness in September.
While most easy-to-find seasonal patterns fall apart when subjected to a bit of scrutiny, this seasonal pattern does appear to be both statistically significant and fundamentally justified.
Most academics attribute the September weakness trend to a combination of tax-loss selling and “window dressing” ahead of the fiscal-year end. In other words, during September, many investors sell poor-performing holdings to help offset capital gains taxes, while some portfolio and fund managers may engage in trades to make their reported results look better before Sept. 30th, the last day of the fiscal year for many funds.
In recent years, other academics have postulated more exotic theories, including the argument that September’s weakness is related to an annual collective bout of Seasonal Affective Disorder (SAD). According to the SAD theory, the sudden onset of fall causes mass risk aversion and investors dump their risky assets.
Leaving the dopamine level of Wall Street traders aside for the moment, and regardless of the exact mechanism behind the seasonal pattern, a soft September has been well documented in many countries. In the United States, seasonal weakness in September has been evident for more than a century. Using data going back to 1896, the market’s average return in September is -1.12%, net of dividends. September’s average is significantly lower than the average monthly return of around 0.60%.
Consistent with the theory that this seasonal weakness results from tax-loss harvesting and window dressing, September losses have been even greater when the market is down year-to-date entering the month, as is the case this year. In years when stocks are down during the first eight months of the year, September’s average loss goes to -3.04% from -1.12%.
To be sure, while many investors pay attention to seasonal patterns to inform their investment decisions and market timing, such patterns are a somewhat frail foundation on which to build an investment approach. Still, investors should be aware of September’s impact on investor behavior, especially during years like this one when the market is weak. While I do believe that equities currently offer good long-term value, volatility is likely to remain high this year. Given ongoing sovereign debt problems, the lingering risks of another recession and calendar-related behavior, September is unlikely to offer much of a respite from that volatility.
Disclaimer: Past performance is not indicative of future results.