entering September

April may be the cruelest month, but for investors September (really, the four or five weeks from mid-September to mid-October) is by a considerable margin the worst month for US stock performance.

The reason is pretty simple. Mutual funds are required by law to distribute basically all their realized capital gains and net dividend income to shareholders. That’s because fund holders have to pay income tax on these distributions and Washington wants to collect income tax as fast as possible. So the government pushes funds to end the fiscal year on Halloween, something that every one I’m aware of does. That gives a fund time to close the books and still pay shareholders before the current tax year ends.

Oddly, to my mind anyway, fund holders like to get distributions and regard them as a mark of fund success. So the approach of the fiscal year end has become the industry’s trigger for managers to realize capital gains. And that turns into the occasion for making a general tune-up of the portfolio. Funds trim outsized winners to create funds for distribution to shareholders. And they also tend to use this tax-selling time to toss clunkers overboard and realize capital losses. In both cases, they sell.

This selling usually begins around the second week in September and dries up in the middle of October, giving trades ample time to settle before the fiscal year end.

Last year during this period, selling was unusually severe, with NASDAQ losing about 15% and the S&P 500 a bit less. This decline also came after a ~5% fall from mid-August highs. But the end of selling also marked an important market bottom.

My hunch is that this year’s experience will be relatively tame, both in comparison with 2022 and in absolute terms. I’m not willing to bet the farm on this thought, but I’m also content not to do any selling based on worries about a repeat of the 2022 losses in 2023.

My biggest concern is that trading bots will mindlessly try to replicate last year’s trading. It will be interesting to see if they do, and, if so, how successful they are.

Two thoughts for you and me:

–there’s nothing to prevent us from doing a portfolio overhaul of our own, something we should all do regularly, and

–if bots run wild, we may have a great chance to buy in a few weeks.

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