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Why are stock markets historically weak in September and October? For answers, I turned to Mark Higgins, senior vice president at Index Fund Advisors and author of the book, Investing in American Financial Historyy: Understand the past to predict the future.
Answers have been edited for clarity.
How is it that September and October are weak months for the stock market? Has it always been like this?
Yes. Wall Street’s worst panics tend to occur in late summer and early fall. This dates back to the 1800s. Some famous examples of extraordinary panics include Black Friday of 1869, the Panic of 1873, and the Panic of 1907.
But why September and October?
This is a byproduct of an old weakness in the U.S. financial system. Before the passage of the Federal Reserve Act of 1913 and the reintroduction of the central banking system, the United States had limited ability to adjust the money supply based on market conditions.
The U.S. dollar is inelastic due to the agricultural financing cycle, making the late summer and early fall particularly volatile. In the 1800s, the U.S. economy still relied heavily on agricultural production. During the first eight months of the year, American farmers had limited demand for funds, so excess funds parked in state banks were shipped to banks or trust companies in New York for a higher rate of return.
When harvest season arrived in August, state banks began withdrawing funds from New York as farmers used their own accounts to fund the transactions needed to get their crops to market.
During the fall months, the agricultural financing cycle created a chronic cash shortage in New York City. If these shortages happen to coincide with a financial shock, the system has little resilience to prevent panics.
How do governments respond to these scares?
The limited ability of the government to respond was a major impetus for the passage of the Federal Reserve Act of 1913. In the lead-up to the bill, leading financiers, most notably JPMorgan Chase & Co., were forced to devise ad hoc solutions that relied largely on private capital. After the United States narrowly avoided a catastrophic collapse of its financial system during the Panic of 1907, there was sufficient political support for the country’s third and final return to central banking.
Does the establishment of the Federal Reserve provide more stability to the market?
Yes, this is obvious if you compare the frequency, intensity, and pain of financial panics in the 1800s. To be fair, the Fed made some mistakes along the way, most notably its failure to prevent the spread of bank failures in the 1930s. But overall, the U.S. financial system has been much more stable since the Federal Reserve began operating in late 1914.
Still, the U.S. economy is no longer dominated by agriculture. Why are September and October still weak months?
People are often afraid of things that have happened before, even if they cannot remember the source of their fear. Perhaps the fall scares have been repeated so many times that they have become a self-fulfilling prophecy. In other words, people expect them, and because they expect them, they behave the way they do (i.e., reduce risk in late summer and early fall) more likely to occur. I know that sounds like an exaggeration, but it does seem like it could be true.
