José Luis Gutierrez | iStockphoto
Why are September and October historically weak for stocks? For answers, I turned to Mark Higgins, senior vice president at Index Fund Advisors and author of the book: Investing in American financial historyj: Understanding the past to predict the future.
The answers have been edited for clarity.
Why are September and October weak months for equities? Has this always been the case?
Yes. The most intense panic on Wall Street usually occurred during the late summer and early fall months. This could go all the way back to the 19th century. A few notable examples of exceptional panics include Black Friday of 1869, the Panic of 1873, and the Panic of 1907.
But why September and October?
It is a byproduct of an old weakness in the US financial system. Before the reintroduction of a central banking system with the passage of the Federal Reserve Act of 1913, the US was limited in its ability to adjust the money supply in response to market conditions.
The inelasticity of the U.S. currency made the late summer and early fall months a particularly precarious time, due to the agricultural financing cycle. In the nineteenth century, the American economy was still heavily dependent on agricultural production. During the first eight months of the year, American farmers had limited needs for capital, so excess funds on deposit at state banks were shipped to New York banks or trust companies to earn higher returns.
When harvest time arrived in August, state banks began withdrawing their capital from New York, while farmers used their accounts to finance transactions needed to get crops to market.
The agricultural financing cycle created chronic cash shortages in New York City during the fall months. If these shortages coincided with a financial shock, there was little flexibility in the system to prevent panic.
How did the government respond to this panic?
The government’s limited ability to respond was the primary impetus for passing the Federal Reserve Act of 1913. The act granted the Fed the power to serve as a lender of last resort during financial crises. Before the law, leading financiers (particularly JP Morgan) were forced to come up with ad hoc solutions that relied primarily on private capital. After the US narrowly avoided a catastrophic collapse of the financial system during the Panic of 1907, there was just enough political support for the return of the third and final version of a central banking system in the United States.
Did the creation of the Federal Reserve bring greater stability to the markets?
Yes, and when you compare the frequency, intensity and misery of financial panics in the 19th century, this is clearly visible. To be fair, the Fed made a number of mistakes along the way, the most notable of which was its failure to stem the contagion of bank failures in the 1930s. But overall, the U.S. financial system has been much more stable since the Federal Reserve became operational in late 1914.
Yet the American economy is no longer primarily an agricultural economy. Why are September and October still weak months?
People tend to fear things that have happened before, even if they don’t remember the origins of the fear. It may be that the autumn panic has repeated itself so many times that it has become a self-fulfilling prophecy. In other words, people expect this, and because they expect it, they behave in ways (i.e., reducing risk in late summer and early fall) that make it more likely. I know this may sound exaggerated, but it seems like it could be real.