September Volatility - Normal is Negative
September has seen the return of some volatility to global stock markets. Many market observers & the financial media are
primarily blaming China, specifically the recent news about Evergrande, a major Chinese real estate company that looks to be heading to default on its loans. The worry in the US and the rest of the world is that these defaults could lead to a contagion effect, rippling through banks around the world. There are a couple of things we wanted to point out about this.
Banks in the US have very little exposure to Chinese real estate. There may be some US hedge funds that do, but not large banks. A default has been considered a dirty word ever since the mortgage crisis in 2008, but that was primarily due to mark-to-market accounting which turned a fire into an inferno. Companies were forced to mark assets to illiquid market prices, which, in turn, made them look insolvent on paper, even if the underlying mortgages were still paying on time. We do not have mark-to-market accounting in place in the US today.
An economic slowdown in China shouldn’t harm the US in any significant way. S&P 500 revenues coming from the greater China area, which includes Hong Kong & Taiwan, accounted for only about 2% of revenues in 2019. The idea that China is the driving force behind the recent market volatility ignores all kinds of other issues such as inflation, a potential tightening Fed, the Delta variant, the debt ceiling, more government spending and possible tax hikes, or simply just the fact that it’s been so long since the last correction. A Chinese real estate company defaulting should probably not be anywhere near the largest of our worries.
There could also be another interesting phenomenon going on called the September Effect. The month of September has historically seen very weak stock market returns. It’s the only month where historically, stocks were more likely to be down than up. And on average, it’s the only month with negative returns.
The theory for the September Effect is generally believed to be that investors return from summer vacation in September ready to lock in gains as well as harvest tax losses before the end of the year. There is also a theory that individual investors liquidate stocks going into September to offset schooling costs for children. We believe that the September Effect is a market anomaly rather than an event with a causal relationship. It is not predictive in any useful way. September usually just stinks for the market. The good news is that October, November & December are a few of the months with the best historical returns!
Bottom Line: It is often said that Bull markets climb a “Wall of Worry.” Meaning, markets go up over the long run despite constant and countless things to worry about. Volatility is a normal part of investing. If we can stomach some volatility, we are usually rewarded over the long run with returns above those of “risk-free” assets like Treasury bills.