A Year Later — Preparing for September 2009

by Inya Ivkovic, MA

September is less than three weeks ahead. I don’t know about you, but I’m already nervous. Why? For the past century or so, the time from Labor Day to Halloween has become almost a regular freak show. I cannot tell you why. No one really knows. It just is.

Last year, Lehman Brothers crumbled and even Warren Buffett believed that the global economy was hours from disintegration. In 2002, the last bear market pushed stocks to new lows. In September 2000, the bear market reared its ugly head. In 1998, the financial crisis made its first introduction and really hit it two months later. In 1987, the infamous Black Friday happened in October, although most people forget it was August when the things started unraveling. And how could I skip 1929? The great market crash happened in October again, but the markets reached the bursting point just after Labor Day. Finally, guess which month proved the worst during the Great Depression? Yep, it was September again, 1931, when the Dow Industrial Average plunged 30%. There is more, unfortunately. The “Great Panic” of 1907 happened in October. The Great Crash of 1873 happened in September.

Gosh, that hurt, it still hurts, and it will hurt some more, perhaps as early as in three weeks. There was even a doctoral student at Georgia Tech who researched the “September effect,” or “Halloween effect,” focusing on 18 stock markets in the developed world and going back up to 200 years, finding that 15 of the sampled markets bled some or a lot of red ink — you guessed it — in September.

Historically, statisticians and quant enthusiasts have reported that, from May through October, the market tends to perform poorly. Investors would typically make their money between November and April, and particularly during year-end rallies. Statistics support the September effect as a real phenomenon. But as to why it happens, why it is so almost every year, researchers and investors alike are simply stumped. The majority of opinions appear to be going down the route of sheer dumb luck, or lack thereof.

There are other a bit more scientific theories, such as that mutual fund companies are to blame. Typically, their fiscal year is October 31, by which point they feel compelled to sell their losing stocks, whose large block trades may end up driving the market significantly down. Also, third-quarter earnings warnings are unleashed in September, often creating a fear atmosphere about weak year-end results. Some are even theorizing that fall crashes are related to the harvest, which is apparently the time when Midwestern banks need capital to pay for the fruits of the land. And there are even such outlandish theories citing seasonal compulsive disorders when, as days get shorter, investors become more risk-averse.

Okay, I don’t know about that last one, but there is obviously much to be said about September and what it may bring this time around. The good news is that there is really very little anyone can do about it. For most investors, trying to get out of their long positions is a moot point, because transaction costs are more likely to eat any defensive profits before August ends and upon reentering the market in, say, November. Also, no one can guarantee any reverse pattern materializing in any given September. After all, in September 2006 and 2007, the markets actually jumped. My advice is simple. September 2009 will come and it will go. Just keep at the back of your mind that it could be a nasty one again, and get ready to hedge your long positions with some shorts perhaps.