To OTC Journal Members:
 

I Don't Trust September

I could have said I do trust September- I trust September to be the worst month of the year. Since October, November, December, and January are generally the best months of the year, September is the best month to accumulate equities ahead of pending gains during coming months.

Well known technical analyst Phil Erlanger recently showed the second half of September is one of the worst times of the year for the stock market. On the left is Phil's seasonality study for a typical September:

Note the accelerating losses in September as you get closer to the later trading days in the month. Hence, if history repeats itself on years that end in 4, I would expect next week to be pretty ugly. It will also represent an excellent opportunity to accumulate your favorite equities before we roll into the the seasonally strongest time of the year.

Erlanger focuses this study on years that end in four. This relates to theories concerning market cycles with a decade. The most prevalent theory suggests the market moves in four year cycles. Within every decade, there are usually lows at the 2s and 6s, and highs at 4's and 00's. More on this phenomenon in a future edition. 

September has been reasonably friendly so far, but don't trust it to remain so. Perhaps this year's tepid September rebound (NASDAQ up about 40 points) is the result of the drubbing we took from May through July.

On average, the S&P 500 drops about 4% in September, and most of the damage usually occurs after options expire (last Friday).

Yale Hirsch, one of the early pioneers in technical analysis, did some interesting studies on this peculiar phenomenon. Here's a table, measuring the percentage performance of the DOW taken from October to April, and April to October over the last decade of the 20th Century:
 

Based on these results investors who bought stocks in October and sold in April made nine times the return of investors who bought in April and sold in October. Yale Hirsch comments: "October was the Bear Killer. Every major postwar bear market ended here except 1970." 

This table, contributed by Jason Goepfert of SentimenTrader, breaks down the September/October relationship more succinctly. Note the average return in the S&P 500 from September to October has been about 1% since 1950. 

An interesting point that jumps off the page: If Sept is an up month there is a 57% chance October will also be an up month. If September is a down month, there is a 63% chance October will be an up month. Either way, we have a pretty good seasonal shot at a strong October.
 
 

Potential Reasons For September Declines and October Surges

I believe the seasonality of business plays a big role in this predictable cycle. Corporations tend to report dismal performance this time of year. During the summer months business slows considerably. In Europe, the month of August is almost canceled due to lack of interest. People use the summer months to vacation and spend time with their families as the kids are out of school. 

Conversely, the 4th quarter tends to be one of the busiest times of the year. Companies who have set annual goals are pushing for business in the last quarter. Many US Government contracts are awarded in the 4th quarter as agencies begin to spend the budgets for the fiscal year. The Holiday Buying Season kicks in, which is huge for the economy since the consumer represents nearly 70% of GDP.

In order to accommodate a healthy Holiday Season, the FED generally pumps liquidity into the system, which helps foster spending. The money flows around, and everyone prospers.

I also believe there is one more, slightly insidious reason for the market's typical 4th qtr surge. Wall Street is a giant marketing machine. This marketing machine knows everyone tends to evaluate their investments towards the end of the year with an eye towards what they will do next year. Wall Street wants you to feel good about being in the market when you do your year end planning. 

What better way to insure a strong fourth quarter than to have the market tank in September.
 

Conclusion

Over the past 25 years, investors who bought stocks in October and sold in April made nine times the return of investors who bought in April and sold in October.

As today is Yom Kippur, the day of atonement in the Jewish Religion, perhaps it would be wise for me to reflect on past market sins and try not to repeat those mistakes. 

We are now coming out of the slowest six month market environment in ten years. This year I stubbornly held on to positions throughout the tepid summer months. I picked up one position at $18 in February. After appreciating to $22, I watched the stock grind its way down to $12 over the difficult May/June time frame. I wasn't smart enough to sell it before it cratered, and I wasn't brave enough to pick up more at $12. With the market slightly more favorable, the stock has now rebounded to $15.

I will be tempted sell the position if and when it climbs back to my cost basis. I am going to try to resist the temptation. Rather, I will try to discipline myself to hold if it appreciates beyond my cost basis and try to make the return I originally envisioned.

In fact, if the stock craters next week in a tough market environment, I might even summon my courage and add to the position. 

In the interim, I have decided to try to capitalize on the usually rough September by purchasing puts on the market. A put is an option you buy when you want to bet equities will go down.

This past week I picked up 60 Oct 35 puts on the QQQ's. They trade under the symbol QQQ.VI. I paid $.70, for a total investment of about $4,200. I will be looking to close out the position within the next two weeks even if it doesn't pay off. If the market doesn't drop, I should be making up the difference from appreciation in my portfolio on the stocks I am long.

This year I am going to sell a lot of stocks if they appreciate seasonally. The rebound has begun. In our universe of eight microcap stocks, six have appreciated off summer lows. NWKI, NWAV, NTDL, FMLY, HYPD, and VTSI have all rebounded in the last thirty days. A hiccup next week should be a great buying opportunity. Pick your favorite, and accumulate. 

By the Spring I hope to have liquidated enough stock to be about 25% invested. I'll never be completely out. I love it too much.

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