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It's beginning to look a lot like September. On Thursday and Friday, the first two trading days of what is historically the worst month for stocks, the S&P 500 lost 3%.
On average from 1950 through 2009, the S&P 500 has lost 0.8% in September, the worst of any month. The Stock Trader's Almanac confirms that September has historically been the worst month for the Dow, S&P 500 and Nasdaq.
September's shoddy record might come as a surprise to those familiar with October calamities like the crashes of 1929 and 1987. But the 1929 crash began with a 10% September decline in the Dow Jones Industrial Average. The 20% drop in the month that followed was no match for the 30% plunge in September 1931, still the worst month ever for stocks. In 1987, a rally fizzled in September before stocks plummeted the following month.
But why is September's record so poor? It could easily be chance. The hard evidence for seasonal effects in stock returns isn't especially convincing, and the explanations I've heard are vague -- for example, that money managers returning from summer vacations use the month to clean out their portfolios. But wouldn't these same managers also buy in September?
I've also heard explanations that, while highly specific, are no more persuasive. One Federal Reserve Bank of Atlanta paper from 2002 argued that seasonal affective disorder plays a role--that a shortening of days in fall in the Northern Hemisphere leads to depression and risk aversion. At the same time, the Stock Trader's Almanac says that cold months are best for stocks, and advocates a November-though-April strategy that it says has beaten a buy-and-hold approach over six decades ended 2009.
My best guess is that monthly stock market effects are random patterns gleaned from unreliably small data sets. The win-loss record of a mere 60 Septembers isn't necessarily more meaningful than the result of 60 coin flips.
For junk bonds, however, the month might matter for a legitimate reason. There are relatively few coupon payments made in September; it is also a month when few bonds come due, points out James Swanson, chief investment strategist for MFS Capital Management: "I'm a strong believer in seasonality in this market."
This year, the junk swoon started in August. Fears of a renewed recession have sent investors fleeing high yield and buying Treasurys. Higher prices have pulled yields on the 10-year Treasury down to 2% from 2.8% a month ago. The junk bond universe, meanwhile, now has an average yield of 8.5%, up from 7%.
The lower prices and higher yields for junk suggest that investors are betting on a broader theme: that an economic slowdown will lead to a rise in defaults. The spread between junk and Treasury yields--more than two and a half times normal levels--implies a default rate of more than 7%. But the default rate is barely 2% now, down from 9% during the credit crisis of 2009. And corporations are stuffed with cash.
Junk could pay off nicely if any rise in defaults is less severe than feared, in which case the September dip could be a buying opportunity. Most investors should dabble rather than load up on the category, using funds with reasonable fees like the SPDR Barclays Capital High Yield Bond ETF (JNK) and the iBoxx High Yield Corporate Bond Fund (HYG). They charge $40 and $50 per $10,000 invested, respectively, and investors pay a standard stock commission to buy and sell.
If the economy tanks as bad or worse as it did from 2007 to 2009, of course, junk could perform poorly. But inflation hawks, take note: junk bonds have often done well during periods of rapidly rising consumer prices. Inflation, after all, reduces the real value of debt, making it easier for bond issuers to pay what they owe. So if inflation eats away at junk bond payments in coming years, it might also result in price gains.
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