FOR EVERYTHING THERE IS A SEASON EVEN STOCK SWOONS
By Mark Ukrainskyj in Trusted Advice
Whether it is at a meeting in Westfield, an event in Hoboken, or in the office in Chester, people often ask us why September and October are such bad months for the stock market. Stock market weakness in the Fall is not a recent phenomenon going back to the late 1800’s and early 1900’s when agriculture was still the major part of the economy. Then, New York banks had to send money to the Midwest to finance crop shipments from the Midwest to New York. This left New York money markets tight on cash and susceptible to downward swoons. This is a less likely reason today as agriculture is only a small part of the US economy. While the stock market is a complex system and there is no one cause for the seemingly annual weakness in the market every Fall, there are some structural reasons behind it.
One possible explanation is embedded in our calendar and how companies report earnings. Most companies report earnings quarterly based on our calendar year. That means they report each quarter’s earnings in the month immediately following, so in April, July, September and the full year in January. Also, they tend to give a forecast for the coming year in January, either when they report earnings or soon thereafter.
If companies miss earnings by a little in the first two quarters, investors may give them some more time. After all, there is still plenty of time for them to make up the small shortfall in the rest of the year. So investors leave the full year estimates alone. Then in August, after the July earnings season, many people, including investors, go on vacation and try to forget about the markets.
When investors come back after Labor Day, they survey the market. They also start thinking about the next year and how companies will do and how they want their portfolios positioned. Coincidentally investors are bombarded with stories that remind them of horrible Fall periods in the past, such as the Great Crash of 1929, Black Monday in 1987, the Financial Crisis of 2008 and others. This tends to make investors skittish and more prone to sell on bad news.
At the same time, company managements are well into the third month of the third quarter and are starting to get a sense of whether they will make their earnings forecasts for the quarter and the year. If they won’t they tend to get the bad news out as soon as possible, so they can focus on next year. This tends to go on into early October as companies that have so called hockey stick sales patterns won’t know if they make the numbers until after the quarter ends. If they will meet or exceed the forecasts, companies tend to wait until their regular announcement in October.
Thus investors returning from vacation are often met with a news flow that is predisposed to be negative as companies get the bad news out first. This combination hits stocks in multiple ways, as they will not make this year’s earnings, and next year’s earnings expectations are also often adjusted downward due to a lower expected base this year. Also, if it appears from the miss, that the company’s growth is slowing, investors may lower the multiple of earnings they are willing to pay. A triple hit. Barring an exceptionally bad economic situation, the news flow then tends to turn around in the middle of October, as the better companies report. And for those companies that exceeded expectations, they get a benefit, as next year’s earnings expectations are generally moved further up and may even get a bump in their earnings multiple.
While this doesn’t always happen, it can be very helpful to understand what is going on behind the scenes and may be driving stock prices. That way investors may not confuse a normal seasonal slowdown with a cyclical economic downturn. With over 100 years of investment management experience between us, this type of knowledge is something we at Covenant bring to the table in service of our clients and their portfolios.