September Blue: The Stock Market’s Most Dangerous Month

 

September Blue

In Mark Twain's novel, “Pudd'nhead Wilson”, there's a quote that goes: "October: This is one of the particularly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February." In other words, the stock market is always risky. Although Twain's remark is witty, it's not true that the stock market is equally dangerous throughout the year. There are periods when the risk is especially high. Let's see the below chart.

Source: Yardeni Research / The Motley Fool

If you look at the historical average monthly returns of the S&P 500, it is obvious that September is the worst month of the year. Interestingly, this trend holds true for the Dow Jones Industrial Average, Nasdaq, the Euro Stoxx 50, or even Nikkei 225. Why is that? In this article, I will examine a few  dates or periods in the U.S. stock market that investors need to be cautious about, yet many retail investors remain unaware of. Through this analysis, I aim to uncover why September is considered the most dangerous month for investing.

(1) U.S. Federal Tax Payment Deadlines

U.S. companies generally pay federal taxes quarterly in four installments. The deadlines are as follows:

• April 15, June 15, September 15, and January 15

Institutional investors often sell some stocks to secure funds for tax payments, particularly for capital gains tax. Therefore, there tends to be downward pressure on the stock market before the federal tax payment deadline. If the market has been in a downturn, there might be little or no capital gains tax to pay, so the impact may be minimal. However, if the stock market has risen significantly, the capital gains tax owed will likely increase, potentially leading to greater downward pressure as the deadline approaches.

(2) Share Buyback Blackout Period

In the U.S., corporate share buybacks are as important as dividends. However, there is a blackout period for share buybacks. This is to prevent insiders from using non-public information for unfair trading. Companies usually set their own internal rules based on SEC guidelines (SEC Rule 10b-18). While the exact period varies by company, the blackout period generally is:

• Two weeks before the end of the quarter until 48 hours after the quarterly earnings release.

While the deadline for earnings announcements varies depending on the corporation's type and tax category, it is typically 45 days after the end of the quarter and 90 days for the fourth quarter. Most U.S. companies release earnings before the deadline, and the dates differ. However, many companies use "two weeks before the end of the quarter" as the starting point for their buyback blackout period. So, investors should be aware of this.

• Mid-March, mid-June, mid-September, and mid-December

When many companies stop buying back shares simultaneously, it can lead to a partial reduction in demand, putting downward pressure on the market.

(3) Quadruple Witching Day

Quadruple witching day refers to the simultaneous expiration of stock index futures, stock index options, individual stock futures, and individual stock options. Like a witch's mischief, this day is notorious for increased volatility in the stock market, making it unpredictable. In the U.S., quadruple witching days occur on:

• The third Friday of March, June, September, and December

On these days, market volatility tends to spike, so caution is needed. Some large investors may try to influence the underlying asset prices to their advantage at the expiration of futures and options. Even if that's not the case, the expiration of existing derivatives (futures/options) can lead to rollovers, position adjustments, or liquidations, resulting in significantly higher trading volumes. As the regular trading session nears its close, the intensity of these activities often increases. This high trading volume and volatility can cause temporary market distortions, attracting more short-term traders and algorithmic trading.

(4) Budget Approval of the U.S. federal government.

The fiscal year of the U.S. federal government runs from October 1 to September 30 of the following year. This is the 12-month period the government uses for budgeting, financial reporting, and accounting purposes. The budget must be finalized and approved by September 30. If Congress fails to do that, it must pass a continuing resolution to keep the government temporarily funded at current levels. Otherwise, the government risks a partial shutdown.

If a shutdown occurs, it not only impacts government services and employees but also affects sectors that rely heavily on government contracts, such as defense and healthcare. Furthermore, the stock market dislikes uncertainty, so market sentiment may deteriorate until a resolution is reached.

(5) Portfolio Rebalancing and Bond Allocation after Summer

Many people take vacations in summer, resulting in lower trading volume and reduced volatility from June to August. As the vacation season wraps up, both portfolio managers and investors typically adjust their holdings and exit certain positions to accommodate new investments. This can create selling pressure.

Meantime, bond issuance significantly slows down during the summer months and then spikes in September, which is often one of the most active months for bond issuance in the year. This rush of new bond issuances can pull some money out of the stock market and into the bond market.

Summary

• Quarterly federal tax payment deadlines: Sep 15 (and Jan 15, Apr 15, Jun 15)
• Share buyback blackout periods start: mid-Sep (and mid-Mar/Jun/Dec)
• Quadruple witching days: third Fridays of Sep (and Mar, Jun, Dec)
• Deadline for annual budget approval for the federal government: Sep 30
• After summer effect: throughout September (rebalancing, bond issuances)

In September, institutional investors may need to sell some stocks to pay quarterly federal taxes, while most listed companies will enter their share buyback blackout periods. Additionally, quadruple witching day on the third Friday can significantly increase market volatility. There may also be a standoff over annual approval of the federal government,  increasing market uncertainty and potentially leading to a partial government shutdown. After summer vacations, investors often rebalance their portfolios, and a flurry of new bond issues may siphon some liquidity from the stock market to the bond market. It’s no wonder September is a tough month. Given this, many investors often adjust their positions at the beginning of the month, well before these events unfold.

Then, why do the Euro Stoxx 50 and Nikkei also tend to decline in September? I haven't conducted separate investigations, but I believe it's because stock markets in developed economies generally follow the lead of the U.S. stock market.

So, Mark Twain's remark is very clever but it's wrong - September is the most dangerous month for stock investments! Thanks for reading. I wish you success in making smart investments!

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