Tuesday, September 4, 2012

What to do With Stocks in September?

Lately I have noticed a blizzard of articles and news commentaries letting investors know the "happy" news that September has historically been the weakest month for stock market returns.

Here's how Ned Davis Research describes it:

Since 1928, the S&P 500 Index has risen only 44% of the time with an average return of -1.11% and a median return of -0.42% during September. The statistics show September as one of the worst months for the stock market historically.

http://www.ndr.com/clients/products/ERB201209021.HTML?source=CRH201209041.HTML

So, after digesting the most recent batch of soft economic data, and recognizing that September is usually a pretty crummy month for stocks, should investors be selling?

I would not, for several reasons:
  1. Any widely followed Wall Street metric often has the nasty habit of being wrong, especially when it is so broadly discussed.  Remember the "sell in May and Go Away" mantra you heard last spring?  It worked for exactly one month (May) and then stocks moved steadily higher.  
  2. While it is true that the historic average return for stocks in September is -1.1%, is only -0.45% in Presidential election years;
  3. According to Ned Davis Research, going back to 1900, stocks typically rally in the period after the election if the incumbent wins.  Even if the challenger wins, stocks move sideways or slightly higher;
  4. The alternative to stock investing - cash and bonds - offer very meager returns to a longer term investor.  
This is not to say that we might not be setting up for a correction - after moving steadily higher since the end of May a retreat of -5% or so in the broader averages would not be a shock - but rather to say that market timing is a very tricky business.

Look at it this way:

Let's just say that you were trying to decide asset allocation in September 2002, and were blessed with perfect foresight into the upcoming events in the next 10 years.

You would see, among other things:  an implosion of the housing market; two protracted wars in Iraq and Afghanistan; a ballooning of the federal budget deficit; a horrific credit crisis in 2008 that would lead to the worst economic period in 50 years; and an economic crisis in Europe that threatened the survival of the euro.

If you had seen all these events coming, you might have been tempted to stash all of your assets in cash, and "wait until the smoke cleared".

But this would have been the wrong decision.

For the 10 years ending August 31, 2012, stocks have returned +88%.  A $100,000 investment in the S&P 500 10 years ago would be worth $188,000, or nearly double the starting value. An investment in small cap stocks would have done even better.

Cash investments, meanwhile, would have offered some comfort, but little return.  Using the 3-month Treasury bill as a proxy, $100,000 parked in cash 10 years ago would be worth $120,000, or a total return of +20%.

Inflation over the past 10 years, by the way, is up +27%, meaning that not only would have a money market fund yielded punk returns, it also would have returned less than the rate of inflation, meaning that you would have lost money in real terms.