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September has historically been the worst month for stocks.
To that point, just two months have delivered an average negative return for stocks since 1945, according to market research firm CFRA: February and September, with the latter being the worst. The Stock Trader’s Almanac reports that, on average, September is the month when the stock market’s three leading indexes usually perform the poorest.
Theories abound as to why this is the case. In fact, many have dubbed this annual drop-off as the “September effect,” which refers to historically weak stock market returns for the month.
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It is generally believed that investors come back from their summer vacation in September and want to sell some holdings to lock in gains for the year. Others speculate that this is when families need money to pay for tuition or back-to-school items. Also, September marks the beginning of the period when mutual fund companies start to pay distributions, which can trigger some tax selling.
While these factors may play a part, the real culprit is likely something more technical.
To start each year, sell-side analysts tend to be overly optimistic, forcing them to cut estimates later, usually after the second-quarter earnings season wraps in August. Those downgrades frequently impact the market the following month, with some institutional investors responding by de-risking some of their positions.
Whatever the case, some experts predict that stocks will again struggle in September. On the surface, it makes sense, especially in light of the recent market losses and the continued impact of high inflation and rising rates.
Still, we could buck the September-selling trend this year. This is because much of the de-risking has already happened, thanks to the historic collapse during the first half of 2022.
Therefore, once analysts conclude issuing downgrades this time around, many stocks will get even cheaper. At that point, institutional investors will jump in and be more active than usual.
This dynamic has already begun to play out in semiconductors. When Micron Technology reported earnings on June 30, it provided lower forward guidance, which caused analysts to cut calendar 2023 estimates by nearly 60%.
Even so, from July 1 to Aug. 4, the stock shot up by more than 18%. The reason? It had already taken a beating earlier in the year, and the downward revisions signaled to investors that Micron had finally been de-risked.
Applying that template to the entire market makes it easy to see why another bump could be coming. Indeed, much of the bad news is already baked in, while the estimate cuts are a sign the bottom is near or has already happened.
Current asset prices reflect future events, thanks to institutional investors attempting to get ahead of everyone else by focusing on what may happen, not what already has. Consider the yield curve.
While many pundits and market watchers obsess about it being inverted, this phenomenon is old news to many institutional investors, who long ago adjusted their allocations in anticipation of this happening. In part, this explains the severe downdraft earlier this year.
Instead, they are much more likely to focus on other factors such as terminal rate expectations, which currently suggest that the Fed will stop tightening policy in December. If so, institutional investors will deploy capital with an eye toward late next spring, when the Fed may be cutting rates.
This means that some of the names hit hard at the beginning of the year could now be attractive, mainly because their valuations already reflect further rate hikes.
For instance, Globalfoundries (GFS), a U.S.-based semiconductor contract manufacturer, has shed about a quarter of its value since April. Nevertheless, it could benefit from an emerging onshoring trend, as many CEOs of domestic companies may be looking to diversify their manufacturing footprint outside of Taiwan.
Meanwhile, biotech company Abbvie (ABBV) should experience a de-risking event after its earnings announcement in October. With its Humira patent set to expire at year end, investors have become nervous about the company’s future.
However, if executives can quantify the impact during the call and chart a clear path forward, Abbvie — which is currently trading at a significant discount — should recover. It now pays a 4% dividend yield and has already launched Skyrizie and Rinvoke to replace Humira.
Over the next few quarters, we will undoubtedly see more bouts of volatility. Moreover, breaking through certain technical levels will be difficult until the Fed stops raising interest rates, which will take more than one good consumer price index print.
Still, it’s reasonable to expect a better-than-usual September.
— By Andrew Graham, founder/managing partner of Jackson Square Capital