Don’t Let September’s Stock Market Rally Trick You

By: Claus_Vogt

You’ve probably heard the optimistic hype surrounding September’s stock market performance. The S&P 500 gained an impressive 8.8 percent during a month that has a bad reputation among stock market investors.

Measuring stock market performance on a calendar basis is indeed common. But that doesn’t necessarily mean it makes a lot of sense. In fact, it’s totally arbitrary to look only at monthly performance figures …

A balanced approach would look at rolling 4-week averages. Or in the case of this September, rolling 22-trading day intervals since there were actually 22 trading days. And if you chose this approach, the above cited 8.8 percent increase becomes a big non-event.

Investors might also find they could have been better off had they listened to an old Wall Street saying: “Sell in May and go away.” And statistics strongly support this simple rule …

Since the end of World War II, nearly all market gains have been when stocks were held from November to April. If you held stocks only from May to October, you actually lost money. This is an impressive and startling calendar phenomenon — certainly much more conclusive than looking at single-month performances.

Another noteworthy point: The low points of the latest correction fell towards the end of August. So recovering from that correction was the only force behind September’s run-up!

And when you look at the huge trading range of the past months, as shown in the chart below, the increase in stock market prices during September looks rather ordinary.

Last month’s performance is said to be the strongest September showing since 1939. Yet if you take a closer look, you’ll see that …

September 1939 Was a Bad Month to Buy Stocks

I was curious to see the context of the 1939 September rally. Well, my findings are very sobering as you can see in the following Dow chart.

The stock market made an important high in 1937; then took a hard plunge. September 1939 was the second high of a double-top, which marked the end of this bear market rally.

From this high the market lost roughly 40 percent until it hit bottom in 1942 when it became clear that Nazi Germany was going to lose the war. This severe bear market was interrupted and became a long, bear market rally.

Therefore, history proves that an impressive September rally can be followed by a huge bear market.

And my indicators are telling me that the September 2010 rally may very well be headed for a comparable fate.

On top of that, there are the recent …

Flash Crash Findings

On May 6 the Dow opened at 10,862.22. Its intraday low came in nearly a thousand points lower at 9,869.62. And the closing price was 10,520.32. This roller coaster was immediately named the “flash crash.” And it left many pundits demanding an explanation as to what might have caused this unusual event.

A mutual fund’s single sell order was behind the infamous “flash crash.”

Now the findings of the SEC and CFTC are in. And they’re very frightening: Nothing special had happened! Yes, there was a $4.1 billion stock-futures sell order … 75,000 E-mini contracts that mimic the movement of the Standard & Poor’s 500-stock index … by a mutual fund company. Although relatively large, it was a normal hedging activity using a computer-generated program.

But since the market was already nervous due to Europe’s debt crisis, this order pushed the market into a tailspin.

This finding is exactly what I had expected …

In my June 9 Money and Markets column, I called the flash crash a warning crack, typically occurring at the end of a huge bull move. It was indeed a warning sign that the bullish forces are fading and a hallmark of a forthcoming bear market.

I also told you to take the flash crash as a harbinger of what this coming bear market will have in store for us. And last month’s gain only makes my argument all the stronger.

Best wishes,

Claus

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