A Brutal September Could Fuel 20% Gains in Stocks

The "September Effect" was especially painful this year...

If you've been investing for a while, you're familiar with this phenomenon. In short, September is usually a terrible month for stocks...

Going back to 1928, equities have lost more than a percentage point on average each September.

That doesn't mean every September is negative... or that it's the worst month for stocks every year. But broadly speaking, it's the most bearish month on the calendar.

This year, the September Effect was much worse than normal. But that underperformance comes with a silver lining.

It has pushed one technical indicator to an important level. And based on history, stocks could rally 20% over the next year.

Let me explain...

The S&P 500 Index falls 1.1% in an average September.

But the index fell 4.9% over the last month... which means this year's September Effect was about quadruple the historic average. Take a look...

Last month was scary for investors. If you felt like no stock positions were working, it's probably because almost none of them were.

One way to measure this is by looking at the percentage of S&P 500 stocks currently trading above their 50-day moving averages (50-DMAs)...

The 50-DMA tracks the average value of an asset for the last 50 days. It's a way to measure the short-term trend. It also acts as a pricing yardstick...

If an asset is worth more than its 50-DMA, prices are higher than normal. And if it's worth less than its 50-DMA, prices are comparatively low.

You can also use this signal to get a sense of market breadth. By tracking what percentage of S&P 500 stocks are above their 50-DMAs, we can see how many stocks are trading at values above the short-term trend.

This indicator just fell to an extreme low...

On September 26, less than 15% of stocks were trading above their 50-DMAs. That's pretty rare... We've only seen conditions like this about 4% of the time since 2001.

In other words, prices are broadly falling. But history shows this kind of setup is a great buying opportunity...

I looked back at every time when less than 15% of stocks were trading above their 50-DMAs. Then, I tested each instance to find out what it meant for the market going forward.

As it turns out, the S&P 500 tends to outperform dramatically after this signal appears. Take a look...

Since 2001, stocks have returned about 6% a year on average using a typical buy-and-hold strategy. But they've performed much better after times like these...

On average, buying on this signal returned 4% in three months, 9% in six months, and 20% in a year.

Returns were also positive a year later 91% of the time. So this signal has a reliable track record.

Septembers are tough for stocks – and last month was a real killer. But stocks are likely to resume their rise from here. Don't get scared out of the market yet... If anything, history shows that now is a good time to buy.

Good investing,

Sean Michael Cummings

Further Reading

After this year's big rally, stocks are taking a breather. The declines started in August. But if you're worried about stocks, don't run for the exits just yet – because history shows the recent pullback is likely setting up double-digit gains ahead... Read more here.

"Stocks have barely dropped... yet sentiment has collapsed," Brett Eversole writes. Professional money managers changed their tune quickly in August. Sentiment flipped from bullish to bearish. But rapid swings like this have been great buying opportunities in the past... Learn more here.

Market Notes



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