Should investors fear the “September effect” in stock markets?

Investors are a superstitious bunch and, over the years, a number of idioms have emerged in the City – some verging on the bizarre. 

You might have heard the old “sell in May and go away” adage, or perhaps you live in fear of the “September effect”. This is the belief that stock markets experience volatility in the month of September. You could call it the investor’s equivalent of the back-to-school blues. 

The phenomenon is supposedly backed by historical evidence. And while we’re only five days into September so far, it is true that both the UK and the US stock market are currently in the red. The FTSE All-World, which gives a decent indication of the direction of global markets, is also down 1.6% so far this month. But surely there is a logical explanation?

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Chris Beauchamp, chief market analyst at IG Group, says it can largely be explained by technical factors in the market as the summer comes to an end and traders swap the beach for the office. “The combination of increased trading volumes and heightened volatility creates a challenging environment for investors, leading to the underperformance seen during this month,” he explains. As a result, the S&P 500 has dropped every year in September for the past four years. 

Higher trading volumes go a decent way to explaining the rationale behind the September effect. But what, if anything, should investors do about it? Should you just grin and bear it, focusing on long-term returns, or can you adapt your investment strategy to mitigate the effects? 

We share some top tips for navigating the month.

Block out market noise and focus on what matters

If markets are in the red, it is important to understand what’s causing the volatility. This can help you distinguish between genuine warning signs and regular market noise.

US equity markets dropped earlier this week (3 September), with stock market darling Nvidia suffering an even sharper sell-off of almost 10%. But it wasn’t the September effect that caused it. 

Weak manufacturing data prompted concerns about the health of the US economy, causing investors to turn bearish. At the same time, reports emerged that the US Department of Justice had issued Nvidia with a subpoena, amping up its antitrust investigation into the AI company.

Beauchamp points out that September is set to be a busy month for the US economy, with several key events lined up in the calendar. With this in mind, investors would do well to keep an eye on each dataset as it is released and adjust their outlook accordingly.  

He says: “One of the most significant [events] is the Federal Reserve's (Fed) policy meeting scheduled for 18 September. The meeting is expected to see a 25 basis point cut, following on from chairman Jerome Powell’s comments at Jackson Hole in August.

“​Another critical event is the release of the August jobs report on 6 September. This report provides a snapshot of the labour market's health, and strong or weak employment data can sway investor sentiment.”

Investors will be hoping to see an economy where inflation is slowing but growth is holding up – the “Goldilocks” scenario. An interest rate cut from the Federal Reserve should also boost markets, as long as the central bank isn’t deemed to have left it too late. 

Take a long-term investment view

One investment idiom that really is worth listening to is this: it’s about time in the market, not timing the market. One of the worst things a DIY investor can do is panic and sell their investments at an inopportune moment. 

“Data from the Barclays Equity Gilt study going back to 1899 shows that over a ten year time period, UK shares have beaten cash over 90% of the time,” says Laith Khalaf, head of investment analysis at AJ Bell. In other words, sitting on the sidelines invariably means you miss out. 

What’s more, the biggest returns usually come in the days after a market drop, and missing out on the recovery can have a big impact on your long-term returns, particularly given how compounding works. With this in mind, investors should avoid making drastic changes to their portfolio in September – or indeed any month – unless they believe the long-term outlook has changed. 

Beauchamp offers some examples of the sort of tweaks that could make good sense. He says: “If interest rates are expected to fall, dividend-paying stocks in sectors like utilities and consumer staples might be attractive. These stocks tend to offer more stable returns and can be less sensitive to economic fluctuations.

“On the other hand, if the US dollar is expected to depreciate, sectors like healthcare and aerospace/defence could benefit, as these industries often have significant international exposure.

“​Another strategy that has proven effective over time is buying during market lows in September or October… This strategy capitalises on the seasonal weakness and positions investors to benefit from the subsequent recovery.”

See our recent pieces on the top investment sectors and opportunities in a bear market.