Stock Market Drop Darkens the Outlook for an Already Bleak Month For Investors

By: Money_Morning

When it comes to U.S. stocks, the first trading day of September typically sets the tone for the rest of the month.

And with share prices having hit a sour note yesterday (Tuesday), investors probably shouldn't anticipate a positive showing for the rest of September.

U.S. stocks nose-dived yesterday, with the Dow Jones Industrial Average plunging 185.68 points, or 2%, to close at 9,310.60 - the biggest hit that blue-chip index has taken in two weeks. The Standard & Poor's 500 Index fell 22.58 points, or 2.2%, to end the day at 998.04 - the first time since Aug. 20 the S&P has closed below the 1,000 level.

The tech-focused Nasdaq Composite Index shed 40.17 points, or 2%, to 1,968.89.

Financial shares led the sell-off, which was sparked in part by growing investor concerns that stock prices have gotten pretty pricey - not surprising since U.S. stocks had rallied 53% from the 12-year lows they'd hit in early March.

More than 80% of stocks that trade on the New York Stock Exchange are trading at prices that are above their 50-day moving average. What's more, in its weekly look at sentiment among the editors of investment newsletters, Investors Intelligence says that its survey shows the widest gap between bulls and bears since the start of last year, Reuters reported.

"People in the market-traders, advisers and individual investors-went from extremely bearish to quite optimistic," Robert Prechter, founder and president of research company Elliot Wave International, told Reuters.

(Prechter was recently interviewed by Money Morning Contributing Editor Martin Hutchinson. To read that report, please click here.)

But here's the real question: Where do stock prices go from here?

Unfortunately, the odds are that share prices are in for a tough month.

As most investors know - and as Money Morning chronicled in a special report yesterday - September is a poor month for U.S. stocks anyway, with an average decline of 1.3% (compared to an overall average monthly advance of 0.5%).

But when stocks are down on Sept. 1, the performance gets much worse, Bespoke Investment Group researchers said in a report they released yesterday.

When the S&P 500 is down the first day of the month, the index declines an average of 1.94% for the rest of the month. But when the index is up on Sept. 1, that rest-of-the-month decline averages only 1.14%, Bespoke researchers concluded.

However, the depth of that first-day carnage matters, too, Bespoke said. Whenever the S&P 500 has posted a Sept. 1 decline of 1% or more, the average decline for the rest of the month jumps to 2.27%, and the index has been positive for the rest of September only 38.5% of the time.

The last time that the index posted a Sept. 1 drop of 2% or better - roughly what the S&P did yesterday - was in 1974, when it dropped 2.26% on the month's opening day. It followed that up by dropping an additional 9.9% for the month. The index also dropped more than 2% (specifically 2.68%) on Sept. 1, 1937 - after which it tacked on an additional loss of 11.85%.

The most recent Sept. 1 decline before yesterday's was in 2002, when in the waning days of a bear market, the S&P 500 posted a one-day drop of 4.15%. It declined an additional 7.15% over the remainder of the month.

But there is some cause for optimism, for there's a difference between then and now - and the difference is a big one, Bespoke researchers found.

After all, the 2002 loss took place "in the waning days of the 2000-2002 bear market, and this September we're in the middle of a multi-month rally."

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