If I could use a single word to describe a theme of this month’s issue, it would be correlation.
It is human nature to confuse correlated events with causal events. Correlated events are ones where there is a pattern of one event followed by another. Since World War II, September has been the worst month of the year to hold stocks. A causal event occurs when one event causes another. The tornadoes which formed over Moore, Oklahoma, a day before we went to press caused the sad deaths of many as well as considerable property damage. (Our hearts and prayers go out to all those who were affected by May’s storms.) On the other hand, the month of September does not cause stocks to fall. Though there are contributing factors, it just so happens that September tends to be a lousy month for stocks.
Understanding what correlations have held up over time can help you put returns into context. An adviser, website or newsletter citing good returns based solely on this year’s performance so far should be approached with skepticism, since January gains are typically followed by full-year gains. At the same time, any market weakness this month should not be a cause for concern since June is the second-worst month of the year for the Dow Jones industrial average, according to Jeff Hirsch of the Stock Trader’s Almanac. Jeff is an expert on calendar cycles and explains the three major ones here.
High valuations are also correlated with stock market reversals, and I think the long-term relationship could arguably be described as causal. The rationale is simple: Higher valuations lead to greater expectations, and greater expectations create more opportunity for disappointment. It is a cycle that has happened continually over history. While asset values can stay irrational for an extended period, unusually high valuations are followed by corrections and bear markets. This does not just apply to stocks either; we are still recovering from the bursting of last decade’s housing bubble.
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