What exactly is September effect? Is it real?

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 What exactly is September effect? Is it real?
Image source: A view of The NASDAQ Stock Market, known as NASDAQ. © Breakers | Megapixl.com

Highlights

  • Historically, markets have seen a negative return in September.
  • However, it seems the issue has taken back state in the recent decade.
  • October has been equally brutal on markets, if not more

Since the beginning of this month, the Dow Jones Industrial Average (Dow 30) has corrected by 2.2%, NASDAQ Composite by 1.5%, and S&P 500 by 1.8%. Outside Wall Street, most other indices except for Japan, India and China have declined.

This abrupt correction is nothing new – it has a precedent. Since 1950, the Dow 30 has averaged a decline of 0.8% during the month of September, while the S&P 500 has averaged a 0.5% decline.

This has prompted the experts to coin a term for this market anomaly – which has no correlation to news/events of the market – The September Effect. The anomaly is applicable to all the markets across the globe and is not specific to just Wall Street.

Over the past 25 years, for the S&P 500, the average monthly return for September is approximately minus (-)0.4%, while the median monthly return is positive.

Even though, in the recent years, the phenomenon has faded as a thing of past, yet it has left a mark on the psychology of investors.

In addition, frequent large-scale crashes have not occurred in September at a rate they used to before 1990s. One plausible explanation behind this change is that investors have tried to counter this trend by “pre-positioning” — that is, selling stocks in August.

But there have been lot of studies over this phenomenon – with rare occasional ones still taking place. Analysts argue that the negative effect on markets can be attributed to seasonal behavioural bias with investors making changes to their respective portfolios at the end of summer.

Yet another reason for this anomaly could be that most mutual fund houses settle their holdings in a bid to make benefits tax losses. Another thing to note here is that many mutual funds experience their fiscal year-end in September. Fund managers, on average, usually tend to sell losing positions before the year end. Experts argue that this trend is another probable reason for the market's poor performance during the month of September.

Another theory indicated that the summer months usually witness lightly traded volumes, as a sizeable number of investors are known to be on vacation and refrain from actively trading their portfolios during this downtime.

With the start of the fall season, the vacation of these investors is over. As they return to the market, they square off the positions they had been planning on selling. When exits happen, the markets witness increased selling pressure, triggering an overall decline.

While there are theories surrounding it, yet there is no proven plausible reason behind this phenomenon. For that matter, October has always been equally bad for markets, if not more. Seen as another one of these seasonal patterns, it has been coined as October likely due to the peculiar history of October market crashes.

The Black Monday crash in 1987 is the most prominent of such crashes.

Going back to annals of history, October was brutal on markets even in 1929.

In 1929, the Dow plummeted 11% on October 24th and then another 12% on October 29th, which kicked off the Great Depression and began a stock market decline that would take more than two decades to recover from.

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