Certain events and numbers hold quasi-mystical significance for investors. One such area is the date. Many investors place significant faith in cycles and seasonal trends.
As I’ve written about in previous posts, most of these biases and patterns do not hold up to scrutiny. However, in the past, one statistically significant bias has been evident: a tendency for equity markets to decline in September.
Knowing this, should investors be positioning for a 2015 “September swoon“? Maybe, but not necessarily because of the calendar.
Starting with a bit of history, looking back over the long-term performance of the S&P 500 index, there has been a tendency for stocks to decline in September. Since 1957, according to a BlackRock analysis using Bloomberg data, September stands out as the only month with a strong, statistically significant bias. Over the long term, the average price return in September has been approximately -1 percent, versus an overall monthly average return of approximately 60 basis points (bps).
September also stands out as the only month in which the market has been down more than it has been up. But what really distinguishes September are the really bad months. The bottom quartile of September observations have an average price return of -3.5 percent, by far the worst of any month. In other words, based on my analysis, when September is bad, it tends to be really bad.
However, investors should note that this “September swoon” tendency has dissipated in recent years. Looking back at S&P 500 returns over only the last 25 years, September’s average monthly return is roughly -0.4 percent, while the median monthly return is actually positive. In addition, big declines in September haven’t been as frequent as was the case prior to 1990. A simple explanation is that as investors have become aware of the bias, they have increasingly reacted by “pre-positioning”, i.e. selling in August.
That said, investors may still want to exercise caution this September, but for a different reason than seasonality: the Federal Reserve (Fed). While the potential for a September Fed hike has been well telegraphed, a rate increase next month could still be disruptive given a slowdown in the global economy and the recent drop in U.S. inflation expectations.
Indeed, the drop in inflation expectations is particularly worrisome. U.S. 10-year inflation expectations (derived from the Treasury Inflation Protected Securities (TIPS) market) are at 1.6 percent, near January lows and down more than 50 bps from a year ago, according to Bloomberg data. Historically, the impact of a Fed hike has been partly a function of whether or not real interest rates were rising. In an environment in which nominal rates are going up due to the Fed, but inflation expectations are falling, real rates would be rising sharply, albeit from a low level. In the past, based on a BlackRock analysis, this combination has been associated with lower returns.
Investors should pay less attention to the calendar and more to the probability of a September rate hike and changes in inflation expectations. These two data points are likely to prove more important in determining whether we get a September swoon than the time of the year.