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Four Reasons Why: You Shouldn't Jump Into the Stock Market in September


Awaiting news on new stimulus measures from the Federal Reserve and the possibility of similar moves overseas, there's a temptation to jump back into the stock market. There also are some very good reasons why that is a very bad idea, ranging from mundane valuation questions to the more offbeat indicators, such as Chinese electrical output.

When it comes to the stock market, poet T.S. Eliot had it wrong: it's September that is the cruelest month of all. True, this September brings with it the hope of fresh rounds of economic stimulus, with next week bringing with it not only the next Federal Reserve meeting (and the possibility of some announcement about a third round of quantitative easing or other initiative aimed at boosting the economy), but also news out of Europe. Next Wednesday, investors will be scrutinizing the Dutch elections for signs as to whether that country will continue to support Germany's hardline pro-austerity approach in dealing with the debt crisis on the country's periphery; a German federal court decision on the European Stability Mechanism (ESM) is also due. (That judgment will determine the constitutionality of the ESM; if it's deemed unconstitutional, brace yourselves for chaos as eurozone nations try to figure out an alternative way to cope with the region's financial crisis.)

That's just the tip of the iceberg. Stock market investors also will have to be prepared to deal with the usual batch of earnings pre-announcements and the rhetoric from the two presidential campaigns as the clock ticks down to election day in early November. So far, at least, the stock market appears to be overlooking or downplaying the potential for economic disruption of the so-called fiscal cliff, and the fact that the highly polarized U.S. Congress may make this still worse. But even without all the political uncertainty, here are four reasons why owning stocks now that Labor Day is over may not be the best investment bet that you could place.

Reason One

Chinese Electricity Production
As we discussed last week, investors have been looking at China's electricity generation rates as a way to forecast the country's GDP. In fact, it may be a better way not only gauge what's happening with GDP but also with industrial production; talking heads now argue electricity consumption may be among the most reliable forms of Chinese economic data. The trend in year-over-year change in electricity consumption falls below the GDP trend at present. That's discouraging to investors already worrying that a recession in parts of Europe and painfully slow economic growth in other developed economies could become a broader global recession, regardless of whatever stimulus central bankers introduce in the coming weeks and months.

Reason Two

U.S. Market Valuations Have Already Risen
The expectation of further stimulus, at home and abroad, has already propelled U.S. stock prices and valuations higher, with the forward 12-month price/earnings (P/E) ratio of the S&P 500 approaching its five-year "new normal" median value of 12.9. (The recent high of 13.5 was reached in February 2011, during the second round of 'quantitative easing'.) That ratio has climbed for reasons associated with both the "P" and the "E": a rally in the S&P 500 index has boosted the "P", while analysts have been cutting their earnings forecasts and lowering the "E". Bulls prefer to see higher earnings outlooks, logically enough, but StarMine data shows that analysts' estimates for S&P 500 earnings growth for the next 12 months are 0.6% lower than they were a month ago. The picture is somewhat more bearish for the broader Thomson Reuters U.S. index, where earnings forecasts are 0.9% than they were a month ago. It's not a stretch to expect that further revisions are, on average, more likely to be negative than positive, especially in the absence of any positive catalyst or an improvement in the broader business environment. Lacking any fundamental reasons for higher valuations, we wonder what might cause the forward P/E to climb further still (i.e., for stock prices to rise) further toward its highs of the last five years?

Reason Three

Risk-On? Sure, But Without Much Conviction
As of early September, the S&P 500 index's total return amounted to about 14%, while the Russell 2000 index, viewed as a barometer of the performance of smaller stocks, is also ahead 14% for 2012 so far. The pledge by ECB President Mario Draghi that the European Central Bank will do "whatever it takes" to preserve the euro, prompted investors elsewhere to join the stock market rally in July. The chart below, which shows the performance ratio of the large cap S&P 500 divided by the smaller cap Russell 2000, highlights an increase in that ratio over a year ago at this time. The most recent spike up in July 2012 (see the green circle, below) highlights the preference by investors for larger, more liquid stocks. That also may be viewed as an indicator that while those investors are ostensibly less risk averse than they have been of late, they still prefer to play it safe. Whether this is a lack of conviction or simply a cautious way of being optimistic about stocks, it isn't a sign that investors are feeling tremendously confident. Low trading volumes during the late summer rally haven't helped to demonstrate that investors are confident about their risk-on bets, while retail investors have spent more weeks pulling money out of actively-managed stock funds than investing in them, according to data from Lipper.

Reason Four

September is "Box Office Poison" for stocks
Historically, September has generated the worst returns for investors in the S&P 500 index, as well as those betting on the MSCI World Index. As the data from the latter, displayed in the chart below, clearly tells us, the third quarter - the period that ends with the month of September - has consistently generated the worst performance of all four quarterly periods since 1991. And while the data show that October has performed better, that month is renowned for its sudden price declines - the infamous "October massacres" - in the U.S. stock market whose data is shown in the charts below. The quarterly chart shows that the third quarter which ends with the month of September, consistently has been the worst performing quarter of the year since 1971. Although October has performed better, the month is famous for its "October massacres" (at least in the U.S. market) and has shown that it, too, is capable of wreaking havoc on investors' returns.

Given these four factors, what's to love about the U.S. stock market in the wake of Labor Day? Well, there is the prospect of stimulus; Federal Reserve Chairman Ben Bernanke made it clear (at least, in the eyes of many economists) on the last day of August during his speech at Jackson Hole, Wyoming that the Fed, at least, is prepared to forge ahead with a fresh round of quantitative easing or some other initiative, possibly as soon as next week. That may be accompanied by other kinds of stimulus from other regions, from China to parts of Europe. But the question lingers: is that going to be enough to outweigh the bearish issues discussed above? At the very least, these considerations may put a damper on investors plunging too heavily into stocks this September.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.