By Tim Courtney, Chief Investment Officer
Many spend their lives searching for the holy grail of investing – a strategy that captures positive returns but avoids risks and downside. And with almost a century of market data to use for research and study, there are several patterns and rules that are said to help in this quest. One such pattern is the "September Effect" – a finding that markets tend to have lower performance in September and October.1 The only month to have a negative average return since 1926 is September, although it’s because of several large negative Septembers during the Great Depression. As it turns out, we’re about to have another negative September in 2023.
Similar observations have led to other calendar-based rules such as "Sell in May and go away," which suggests investors stay out of the market during the summer and fall months. Returns have been lower but positive in these months, and avoiding them would have led to a large amount of lost returns and compounding. You might also be familiar with the Santa Claus rally in December and the notion that January's market performance can predict the rest of the year.2
Humans are excellent at spotting patterns, which is a beneficial ability and has helped us better understand our world. But sometimes this ability can lead us astray. Meaningless or random patterns will occur naturally in large sets of data. As popularized in the movie “A Beautiful Mind”, the brilliant mathematician John Nash discovered patterns in print media that were nothing more than coincidences. Others have found patterns in large books such as the Bible or Moby Dick. With nearly a century of stock data and supercomputers looking for patterns, we will find some. The question is: are these patterns purposeful or caused, or are they random?
This brings up the study we’ve mentioned before that pitted humans against mice. Mouse and man were separately placed in front of two lightbulbs with buttons underneath. The goal was to have the subject press the button under the light they thought would next flash. If they guessed correctly the subject would get a reward. There was a pattern to how the lights flashed in that one flashed 80% of the time and the other 20%. However, the order was random. The humans could recognize that one lit up about four times as often as the other. They pressed the button under the light they believed was “due” to flash. But because the order was random they often guessed incorrectly and had a success rate of about 68%. The mice quickly discovered that one light paid a reward most of the time, and they only pressed the button under that light. They guessed correctly about 80% of the time.4
The market has a comparable pattern and random order. Market history shows that markets are positive in roughly two-thirds of all months, quarters and years.3 However, the performance of the previous period doesn't reliably indicate what will happen next. Regardless of whether the prior month, quarter or year was positive or negative, the next period is positive about two-thirds of the time.
This is not to say that all patterns in markets are meaningless. However, it is to say that performance patterns have been tied to some level of risk being present. We believe our best approach is to acknowledge and manage the risk necessary to capture returns.
Sources:
- Yahoo! Finance (8/31/23) — September is historically an awful month for stocks — but maybe not this time
- Investopedia (11/4/22) — January Barometer: What it is, how it works, example
- DFA Returns: S&P 500 Index Monthly Returns
- EconomicTimes (4/2/2010) – Of Rat’s Pigeons, Bulls and Bears
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.
