What is the September Effect?

Key Highlights

• September Effect refers to a market anomaly where the September stock market performs relatively poorly.
• According to some, investors' consumption of cash at the end of the season may be the reason for the September Effect.
• Some statistical evidence may exist for the September Effect, but it depends on what period you examine.
• According to most economists and market professionals, the September Effect does not exist.

Understanding September Effect

When it comes to the September Effect, there is no cause-and-effect relationship, and it is not limited to any particular nation's markets. However, there are few logical explanations as to why the September stock market occurs.

From 1928 to 2021, the S&P 500 index has averaged declines during September. While September isn't the worst month of stock-market trading every year, it is an average observed over nearly a century. However, for some years, September has delivered the best results.

Though the September Effect violates the assumption of efficiency in the market, it is not overwhelming and is not predictive in any useful sense. This is because the time period under consideration matters greatly.

For example, an individual who bet against September over the last 100 years would have made a profit. In contrast, if the investor had made that bet only since 2014, he would have lost money.

Reasons for the September Effect

Here are the possible reasons for the September Effect:

• The general belief is that investors are ready to lock in gains and tax losses by September after they have returned from summer vacation.
• It is also believed that investors liquidate stocks to cover schooling costs for their children in September.
• Since investors expect the September Effect to occur, market psychology takes hold, and sentiment turns negative as a result.
• It is also possible that institutional investors will sell towards the end of September as the third trading quarter comes to a close. As the year comes to an end, they can lock in some profits.
• Many significant mutual funds cash in their holdings to harvest tax losses at the end of the quarter, which could be another reason.

Although economists dismiss the September Effect as irrelevant, they also acknowledge that if it ever existed, traders who were aware of it would now act in such a way that it would disappear. In addition, large declines in September have not been as frequent as they were before 1990. A potential explanation is that investors have reacted by prepositioning, i.e. selling stock more in August.

The October Effect vs. September Effect

In the same way that the September Effect has no precedent nor cause-effect reasoning, the October Effect also has no cause-effect reasoning or precedent. As opposed to the September effect, the October effect often sees positive market returns and performance.

While the September Effect has negative performance over 100 years, the October Effect has shown positive performance, even in times of economic turmoil and unforeseen, usually market-devastating events. Even though experts have seen the October Effect decline in recent years, it still seems to have a positive impact on the market, with only anecdotal evidence explaining this.

The September Effect is also a market anomaly rather than an event with a causal relationship like the October Effect. This also suggests that October can be a negative month for the stock market. However, October's 100-year history is generally positive, even though it was the month of the 1907 panic, 1929's Black Tuesday, Thursday, and Monday in 1929, and Black Monday in 1987.

However, September has seen an equal amount of disruption. During this month, the first Black Friday occurred in 1869, and two major dips occurred in the DJIA after 9/11 and during the subprime crisis in 2008. October Effects are also dependent on the period under consideration, much like the September Effect. The October Effect is also discounted by economists and analysts, and if it once existed, it seems to have disappeared as well.

Is the September Effect Real?

September Effects may or may not exist, depending on the time periods under consideration. The September stock market has historically been the worst-performing month for stocks over the last century. Additionally, it has been the most frequent month of decline over the same period. However, most economists attribute the effect to chance (one month must be the worst, after all).

Researchers took even longer time horizons (using U.K. data since 1693) and found no evidence at all for the Effect. For 3 out of 6 sub-periods of 50 years, September returns are higher than the other months, although the difference isn't statistically significant.

Conclusion

The September Effect is an unusual occurrence in which stocks turn negative in September. Despite September's worst performance and most negative performance over the past century, the time period under consideration matters greatly. There is no definitive science or rationale for why September has historically been the worst month for stocks. However, the sample size is large enough to suggest that investors should be prepared for the September stock market decline.