What is the September Effect?

It was another classic September. The market was down once again. It seems like every September the market sells off. Historically, September has been the worst month for the stock market and 2023 was no different. The same thing happened in September 2022. September 2022 was the lowest month of the year, and the rally began on October 12, 2022.
In January of this year, I wrote in a newsletter:

“Remember, things are never clear until it’s too late.”
― Peter Lynch, One Up On Wall Street: How To Use What You Already Know To Make Money In
Peter Lynch is one of the great modern investors; during his 13 years managing the Magellan Fund, Lynch averaged a 29% return annually. Lynch was not unlike most great investors. He had times when the Magellan Fund that he managed had significant times when it was down. He knew, when the doom and gloomers were forecasting bad times to continue, that no one had a crystal ball. By the time the doom and gloomers changed their mind and realized the market was headed up and not down, it was too late.
There are now several indications that we have seen the bottom.

$500,000 invested on October 12, 2022, in the S&P 500 total return would, by the end of January be worth $572,684, a recovery of 37% of the S&P 500 TR point loss. $500,000 invested in the AFC composite on that same date would be worth $732,650. There seems to be a general recovery, but it is a mixed bag with some companies doing very well and others suffering. Being in the right stocks at the right time seems to be important.
We have information now that Lynch did not have during his investing hay day. Edward Renshaw of the University of New York at Albany published a study showing that if 90 days following the bottom, the market had recovered approximately 33%, then the bottom had been reached.[1] This would mean, finally, that the market was on the way to full recovery. Renshaw studied all the times from 1872 until 1990 that the market had sold off 5% or more. There were 42 occurrences in those 118 years. In 29 of those 42 selloffs, a recession was already in process, while 13 of them occurred during good economic times. In each of those 42 occurrences, the market recovered around 33% 90 days after the bottom had been reached. That study was completed in 1990, but that held true in the 1994 sell off, the 2000 dot-com crash, and the Great Recession of 2008. So far, it has been correct 100% of the time.

The question is why does September act as it does. There are a number of theories. One says that investors are returning from vacation and school is starting. Investors begin taking losses for tax purposes. Another theory is mutual funds tend to take losses as the third quarter ends in September.
Economists who believe in the rational efficient market theory say the September Effect does not exist. If it existed, then rational investors would understand and begin to sell in August to beat the crowd.
In my opinion, none of that makes sense. What does make sense is this: computer algorithms make 65% or more of trades. Those algorithms are built to analyze past data and respond in the same way. So when September 2022 was a down month computers begin to sell and short with the trend. To get ahead of the September downturn, the computers would need to begin selling in August.
Selling in fact did begin in both August 2022 and August 2023. In 2021 selling did not begin until September. Maybe the efficient market theorists have some credibility. The computers see the September Effect and have shifted some of the selling into August.
If my hypothesis is correct, we should start seeing the market shift into an upward trend in early October.
Then again, with the threat of government shutdowns, impeachments, and indictments maybe there will be a whole new pattern.
Peter Lynch achieved his remarkable returns by staying invested and not trying to time the market. The late Jack Bogel, founder of Vanguard said this: “The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently.”
Riding through the downturns is no fun. In fact, it is downright tough. But those great investors like Peter Lynch, Warren Buffett, John Templeton, and Rowe Price all stuck with their investment strategies even when their portfolios were down significantly. I always have to say that past performance is no guarantee of future performance. But is there any better indicator?

Mike Adams
President & Principal

[1] Renshaw, Edward. “Is the Stock Market More Stable than It Used to Be?” Financial Analysts Journal 51, no. 6 (1995): 81–88. http://www.jstor.org/stable/4479887.