Stocks: Another Scary September Market?

A year ago the perfect storm of too much leverage and the housing bubble brought down many financial companies, including Lehman Brothers, which filed for bankruptcy on Sept. 15, 2008. The financial crisis pushed the Standard & Poor's 500-stock index down 9% last September and set the stage for a further 17% plunge in October.

September's reputation for danger is indeed deserved. The 1929 stock market crash began in September. During the subsequent September, in 1930, the Dow Jones industrial average fell 15%. Even worse, the index plunged 30.7% in September 1931, still the worst September in the Dow's history. More recent Septembers have brought S&P 500 plunges of 12% in 1974 and 11% in 2002.

According to the Stock Trader's Almanac, the S&P 500 index drops an average of 1.1% in September, making it the worst month of the year. That history weighs on the minds of traders and investors as we enter September 2009.

"There is a high level of caution among professional traders," says Nick Kalivas, senior equity analyst at MF Global (MF). Other than the calendar, there are plenty of good reasons to be wary, Kalivas says. He cites skepticism about the economy, the expiration of stimulus to auto sales and the housing market, and worries about corporate results and policy proposals in Washington.

mild summer trading, then big volume?However, Kalivas says, memories of last fall—including the collapse of Lehman Brothers—are still fresh. "September and October have been volatile periods for the market," he says. "It's going to be interesting to see how people greet the lapping of what happened last fall."

One theory to explain September's poor track record is that summer's end makes big market swoons more likely. Trading volumes are lighter during the summer. In September, professionals return to the office and start plotting strategy for the last quarter of the year. "Everyone coming back to the market at once creates more volatility," says Mike O'Rourke, chief market strategist at brokerage BTIG.

Some dismiss the September phenomenon as mere coincidence. Out of all 12 months, "one of them has to be the worst performer," says John Merrill, chief investment officer at Tanglewood Wealth Management. He also dismisses the "end of summer" theory, saying modern investors don't take the summer off. "I don't know of any decent-sized investment firm that goes on autopilot," he says.

Even for those who accept that the stock market is, for whatever reason, naturally treacherous in September, that's rarely sufficient reason to alter their investing behavior. O'Rourke, for example, thinks the economic recovery could outweigh negative seasonal effects this year. "I'm not going to make an investment decision based on just the month of the year," asserts John Wilson, chief technical strategist at Morgan Keegan.

Another common investing truism is "Sell in May and Go Away," based on the poor performance of stocks over the summer. But since May 1, the S&P 500 is up 18%.

Needed: exciting, upbeat newsThat strong run worries Wilson. August will likely be the sixth consecutive month of gains for the stock market, giving the S&P 500 a 40% leap since March—the kind of performance that's hard to sustain without a break. "Clearly, we're due to at least go sideways for a bit," Wilson says. "We could get a correction in here."

James King, president and chief investment officer at National Penn Investors Trust, expects a tougher September. After months of gains, "the markets want some new exciting news," King says. They're unlikely to get it with the economy recovering so slowly. "Things are plodding along, with modest, slow improvements," he says.

Tanglewood's Merrill, by contrast, believes the stock market is in a "positive cycle," where better-than-expected news is building on itself. When it comes to the economy, "the vast majority of statistics have been better than expected," he says.

Many analysts, including Merrill, O'Rourke, and Wilson, believe a correction for the stock market in the fall could be shallow, if one happens at all. Hundreds of billions of dollars were pulled from the equity markets in the past year and stored in cash accounts, and that hoard could return as conditions improve.

Whatever happens this autumn, the month of September will not be the prime factor. This time of year may be fertile ground for market meltdowns, but any such event would undoubtedly be triggered by economic or corporate news, not by the calendar.

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