Another September Slump on the Way?

Stocks have shown a tendency to retreat during the month, and S&P has identified a number of potential reasons for the weakness

September has always been a problem for equity investors. It's the only month in which the Standard & Poor's 500-stock index has averaged a decline from 1990 to the present, 1970 to the present, 1945 to the present, and 1929 to the present. In each of these periods, the S&P declined in September more than half the time.

Why the tendency toward a September slump? We believe the reasons could be as follows: 1) Investors returning from vacation see their portfolios in shambles, which results in further carnage; 2) a lack of capital inflows, as bonuses, tax refunds, and pension/IRA contributions already have largely taken place; 3) analysts reducing their full-year earnings estimates and target prices, as there is little time left in the year to make up projected shortfalls; 4) companies typically start the budgeting process after Labor Day, possibly dampening the mood of managers who communicate with investors; and finally, 5) mutual funds with October fiscal yearends may begin selling losing stocks.

Since 1990 (the date to which S&P 500 sector index data extends), the S&P 500 fell an average 0.8% and posted monthly declines 53% of the time. Also interesting is that six of the 500's 10 sectors recorded negative average price changes in September, as well as frequencies of decline.

S&P 500 Results in September Since 1990
S&P 500 Sectors Avg. % Change Avg. Freq. of Decline
Materials (2.5) 59%
Consumer Discretionary (1.6) 59%
Consumer Staples (0.6) 59%
Information Technology (1.7) 53%
Industrials (1.1) 53%
Energy 0.7 53%
Health Care 0.9 47%
Financials (0.6) 41%
Telecommunication Services 1.4 41%
Utilities 0.2 35%
S&P 500 (0.8) 53%

Source: Standard & Poor's Equity Research

Of course, there is no guarantee that the market will tumble this time around. S&P believes the recent pullback in the S&P 500 from its July highs has probably gone as far as it will, even though another retest of the 1370 intraday low and 1406 closing levels may occur.

Four Categories of Sell-Offs

I mention these seasonal weaknesses not in an attempt to fan investors' fears but to alert them to these patterns, and to suggest they not react hastily and do harm to their portfolio's longer-term potential return. If fear and greed dominate the near-term trading actions of many, I believe that a more complete understanding of stock price movements may serve as virtual Valium by calming jittery nerves enough to stop investors from becoming their own worst enemies.

As I have previously noted, I segregate market sell-offs into four categories: 1) noise, in which the S&P 500 falls between 0% and 5%; 2) pullbacks, where declines range from 5% to 10%; 3) corrections, which shave 10% to 20% of the market's value; 4) bear markets, in which the S&P 500 tumbles more than 20%.

Since 1946, the S&P 500 has experienced 49 pullbacks, 16 corrections, and 10 bear markets. Average price declines were 7% for pullbacks, 14% for corrections, and 32% for bear markets. Pullbacks, corrections, and bears (PCBs) have lasted an average of 40 (a little over a month), 148 (five months), and 490 (1.3 years) calendar days, respectively.

A Lot to Look Forward To

More interesting, in my opinion, has been the speed of average recovery times: 58 days for pullbacks, 111 days for corrections, and 669 days for bear markets. In other words, the S&P 500 returned to its starting level in an average of only two months after pullbacks, less than four months after corrections, and about 1.8 years for bear markets.

In addition, history shows (but does not guarantee) that once these downward events have played out, investors could look forward to: 1) a subsequent rise of 8% for pullbacks until the next event occurs, usually in 90 days; 2) an advance of 10% in the following 111 days after a correction; and 3) three-and-one-third years of bull-market bliss, as well as an 81% advance in price, after the bear markets have come to an end.

Finally, the only times that the S&P 500 did not recoup all that it lost in a prior bear market in fewer than two years was following bear markets in excess of 40%, which occurred in the early 1940s, early 1970s, and early in this decade. So if this pattern holds true, we won't likely see another one of those mega-meltdowns for another 25 years.

S&P 500 Declines Since 1946: Magnitudes, Durations and Recoveries
Sell-Off Type Count Avg. % Chg. Duration in Days # Days to Recover Subsequent % Change Days to Next Decline
Pullbacks 49 (7) 40 58 8 90
Corrections 16 (14) 148 111 10 111
Bears 10 (32) 490 669 81 1187

Source: Standard & Poor's Equity Research

So there you have it. PCBs wreak psychic havoc, but with a firm understanding of stock market history, investors may be able to talk themselves out of doing something rash while the downturn runs its course. That said, the possible weakness in September reaffirms S&P's cautious outlook on the market—as seen with our yearend target for the S&P 500 of 1510—and our overweight recommendations to the energy and health-care sectors.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (8/29/07)
Auto Parts &Equipment Johnson Controls (JCI) 3 $111
Commodity Chemicals Lyondell Chemical (LYO) 3 $46
Computer Hardware Apple (AAPL) 4 $134
Construction & Engineering Jacobs Engineering (JEC) 5 $64
Construction & Farm Machinery Trinity Industries (TRN) 5 $37
Consumer Electronics Harman Intl. (HAR) 3 $113
Diversified Metals & Mining Freeport-McMoRan Copper (FCX) 3 $85
Fertilizers & Agr. Chem. Monsanto (MON) 3 $68
Footwear Nike (NKE) 4 $55
Internet Retail (AMZN) 2 $79
Oil & Gas Equip. & Svcs. Schlumberger (SLB) 5 $96
Steel Nucor (NUE) 4 $53
Technology Distributors Ingram Micro (IM) 4 $19
Tires & Rubber Goodyear Tire (GT) 3 $28

Source: Standard & Poor's Equity Research

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