Will Stocks Survive September?

In my Money Week column this week, I've been looking at whether there is going to be a correction to the stockmarket rally in September and October. Here's a taster....


The autumn has always been a scary season for the stock market. From the Great Crash of 1929, in October of that year, to the crash of 1987, also in October, to the collapse of Lehman Brothers, in September last year, it has always been the season when investors step up to the abyss, look down, and for some odd reason decide to hurl themselves straight into it.
And this year? Get ready for a September Surprise. After the strong rally of the last six months, the markets are poised for a brutal autumn correction. Companies are going to be looking to the markets for vast quantities of cash; the boost provided by stimulus spending is going to fade; the emerging markets are about to come juddering back down to earth; and, in the UK at least, there is likely to be a renewed bout of political turmoil as Gordon Brown’s dismal premiership enters its last, rockiest months. All four factors are likely to be make the next two months a bumpy ride for investors.
No one can have failed to notice the strong performance of the markets in the last five months – even if plenty of people were too slow to take advantage of it. In the US, the S&P 500 index has rallied by 49%over that period. Most of the other markets around the world have performed just as strongly. China’s Shanghai Composite Index, the best performing major index, is up by 78% so far this year. Even the UK’s FTSE, which hasn’t been one of the better performing markets for years, is up by 11% over the last six months even though the British economy shows few real signs of climbing out of recession. The MSCI World Index, probably the most accurate gage of global sentiment, has climbed 54% from a 13-year low touched in March.
But can it last? The historical precedents aren’t good. September has always been the worst months for US stocks: taking an average of every year since 1928, stocks have fallen by 1.3% during that month. The only other month that is such a consistent loser for investors is February. Some of the Septembers along the way have pretty scary. Last year, for example, the S&P fell by 9% following the collapse of Lehman Brothers. Back in September 1931, as the depression started to acquire that rather frightening looking ‘great’ in front of it, stocks fell by 30 percent, wiping out all the gains from the bounce back after 1929.
Even if you happen to get through September unscathed, there is always October to worry about. The precedents of 1929 and 1987 suggest that can be just as brutal a month for investors.
Of course, those are all just co-incidences. Just because the autumn has often been hard on the markets in the past doesn’t mean that it will be this year. Still, there are four reasons for thinking there is a surprise in store for investors this September, and it won’t be a pleasant one.
First, companies are desperate for cash. Lloyds Bank suggested last weekend it would be tapping the markets for money to replace the state as a shareholder, and that is just one example among many. There are lots of battered balance sheets out there, and the stock market is just about the only place where funds can be raised to put them back into shape. Already there have been 315 IPO’s this year as deals frozen in the credit crunch get bought back to life. But all that extra stock coming onto the market is going to soak up available funds, and will stop prices from rising as fast as they have been.
Next, the initial impact of the stimulus programmes put in place by governments around the world will start to fade. Even a patient near death will perk up if given a massive injection of adrenaline, but that doesn’t tell you very much about their underlying health. It would be a surprise if big increases in government spending, central banks printing money like crazy, and record-low interest rates, had not revived the economy. But governments can only shift spending from one period to another. They can’t permanently increase it. Over the next six months the impact of all those stimulus programmes is going to fade out of the system, revealing economies that are very weak underneath it. When that happens, investors are going to have a nasty fright.
Thirdly, this rally has been led upwards by the emerging markets. It is the Chinese, Brazilian, Indian and Russian markets that have led the upswing, the so-called BRIC economies. No surprise there. With high-saving rates, rapid industrialisation, and hard-working labour forces they look a far better bet than the developed economies of Europe and North America. Yet they remain volatile, and gains of 70% or more in a year are likely to be checked. When they are, investors around the world will take fright. Without the BRICs to drive it, there are very few reasons for feeling optimistic about the global economy.
Lastly, the UK has some political turbulence ahead. Gordon Brown’s government will limp miserably into the last political season before its demise. Don’t assume that Brown will survive: the Labour Party shows little will to live right now, but it must know it is being led to slaughter. Even without a change of Prime Minister, as he election campaign gets underway, as it will once the party conference season opens, the currency and gilts market may well wobble. Neither party shows much willingness to discuss the scale of the fiscal crisis the UK faces, and at some point that will make anyone holding assets in sterling feel nervous.
Whether the last five months were just a bear market rally, as the sceptics will tell you, or whether they were the foothills of a genuine bull market, no one can say for certain. There are good arguments on both sides of the issue. But one thing is for sure. Market never move either up or down in a straight line. Whichever it is, there will be bumps and reversals along the way. This market is due a correction. And September is the most likely time for it to kick-in.