September Swoon?

As we approach September, we have a fair number of fear mongers worrying about September and how it is historically a bad month for the stock market and is probably when we will get "the correction".


Of course there are a number of reasons that there have been significant moves in September and October, primarily the fact that activity picks up after summer doldrums. During the summer, one of two things happen. Either the market moves in the direction that represents overall market sentiment, or it moves in a contrary direction.

Because of the low volume that we normally see during the summer, it is an opportunity for market movements that would not occur when the market is more actively traded. The old adage of sell in May and go away, has some validity. However, as technology has made it much easier to keep on top of things, even when away, not as much as it once did.

If the market has moved in accordance with general market sentiment, whatever trend it exhibits will most likely continue in September and October, barring of course other news. On the other hand, if the market has moved in a contrary fashion, especially if it has moved up, we are likely to see a significant adjustment.

So, has the market movement been part of a larger trend or has the movement during the summer been contrary to the overall trend?

If you look at projected S&P earnings for the 4th quarter of 2009 on an annualized basis, the S&P is trading at about 17 time those earnings. This is actually somewhat below what it has been doing for the last few years when it has averaged closer to 19. Now, is you consider that 10 year treasury yields are about 3.5%, the S&P yield of about 5.8% gives you a 2.3% risk premium. This is not very much out of line with what you would expect to see, although a little on the high side.

So the current level of the S&P, while much higher than it was in March, does not seem out of line with where one would expect it to be objectively. Now other things impact the market and it is possible that sentiment could drive prices down somewhat. However, there really doesn't seem to be the tremendous overvaluation that some talk about and if you want to maintain a 2% risk premium, the market still has room to go up. Now if you look at the 1st quarter of 2010 earnings, annualized, they would justify an S&P level of close to 1200. Now, earning can come in lower, but I believe most of these estimates are on the low side.

So will the market drop in September? It might, but the fundamentals don't support that the market is wildly overvalued and if it does drop I would expect it to rebound rather quickly as stocks become bargains.