September is supposed to be cruel for stock market investors. This year, it's weighted with even more potential volatility because the Federal Reserve circled it as a potential start date for "tapering" its long-running cash injections that have been bolstering the economy. But month's end could bring a pleasant surprise, some market analysts say, if it includes new clarity on the heightened uncertainty now hampering the market.
For now, markets remain wary, with the Fed still deciding when precisely to wean the U.S. economy off its $1 trillion a year in bond purchases. That will likely cast a long shadow during a month when markets tend to dip.
Here's that history: September is historically the market's worst month, with a 1 percent average monthly drop and a "negative" result 57 percent of the time, according to Ned Davis Research. October is historically the most dramatic month, with huge one-day flops in 1929 and 1987, and in the 2008 crash, October's losses were bigger than September's. Even some strategists who don't put much stock in historical trends or calendar-specific prognostications say the next couple of months could be dicey.
"I don't normally scrutinize seasonal and technical indicators too closely, but there are some negative factors," says Jerry Webman, chief economist for OppenheimerFunds. He adds that disturbing technical signs are showing up before the start of the scary season – factors such as excessive optimism and lack of buy-in after the market starts to rally. More important in September will be the outcome of events in Washington, and none more so than the Fed's moves.
Bonds, too, have already had a few really tough months, and heading into September the complacency of bondholders could mean continued misery, especially if the Fed makes a stronger-than-anticipated move to cut easy-money policies. Despite months of warnings, many people with bond-heavy savings plans are unprepared for the chance that interest rates will rise further. And bond prices, which decline as rates go up, could fall sharply.
"The story has not played out fully yet. Some people have been surprised about the impact on an asset class that they thought could not lose money," Webman says. "And certainly they were not expecting they could have a 20 percent loss in a year, which it hasn't reached. But it's close." (One example, the iShares Barclays 20+ Year Treasury Bond index, has fallen 18 percent since April 1.)
Investors' love affair with fixed income began after the 2008 stock market crash, when they piled into bonds at an unprecedented rate. They jumped back into stocks at the start of 2013 but kept buying bonds too before pulling back from the sector during May and June when government bond prices fell 10 percent.
Still, many people are not aware of how badly they can get burned from too much exposure to bonds. A recent survey from wealth management firm Edward Jones says 63 percent of Americans "don't know how rising interest rates will impact investment portfolios" such as 401(k)s, individual retirement accounts and other savings plans. A quarter of respondents say they are "completely in the dark about the potential effects" of fixed income on their portfolio.
Uncertainty is growing on a number of fronts."There are four big things – the scaling down of the Fed's easing policy, Syria's worsening situation, the resumption of the debt ceiling fight and that September effect," says Mark Germain, president of Beacon Wealth Management. He notes that many equity managers raised cash in August to reinvest after a possible market decline. His strategy now is "stay the course in equity markets and use pullbacks as an opportunity to find new areas of growth." For stocks, a September selloff is strong possibility, he says, followed by a recovery by year-end. Bonds prices are likely to be depressed for some time to come once the Fed launches its tapering.
Oppenheimer's Webman agrees "there will be no safe haven" if rates rise – and stocks will be hit as well. But sticking with equities is a smarter bet, he adds. Any September decline in equities "could be a buying opportunity," he says. While bonds could be pressured for some time, many strategists say stocks will muddle through this unusually storm-clouded September and could end up in a better position.
So what's the bullish case? Webman says the Fed's tapering will eventually arrive, perhaps in a later month. If the Fed holds off on tapering altogether, the market would likely stage a "relief rally." When the Fed does slow bond purchases, some of the market's recent uncertainty will disappear. The same can be said of the budget deficit battle looming in Congress and the related fight over funding Obamacare, and a possible change of leadership at the Fed when Ben Bernanke steps down.
"Blaming the government is not an investment strategy," Webman says. "Financial markets don't price our political preferences. They price the future earning capacity of real businesses."
If that's the case, stocks might hold their ground. Even if the Fed tapers and rates rise, the equity outlook remains positive, he says. One of the most encouraging economic factors this year has been the ability of the housing market to continue improving despite tight bank credit and sharply rising mortgage rates. "Housing continues to be one of the strengths of the U.S. economy, along with autos and energy," Webman adds. Waning worries over growth in China and Europe are also starting to remove some of the clouds over the global economy, he notes.
"The disruptions we face next month will not be too damaging to the economy," he says. "But there might be volatility in the market."
But when some of the burning questions facing investors are answered, cruel September could end with a surprisingly strong equity market. "The stock market is in pretty decent shape," Webman says. "I maintain my optimism. I believe equities will continue to rise."