What happened to the market in August and September?

Between July and the end of September, markets lost between 13.5% (Dow) and 27% (Emerging markets) depending on which market you are looking at.

I pored through economic data and could not see any marked deterioration in the economy. In fact, on balance, I see continued slow improvements.

Pundits attribute the market tumble to 1) political gridlock in Washington and 2) the European debt crisis. I don’t buy either of these explanations.

Some pundits fondly recalled how former House Speaker Tip O’Neill was able to work with President Reagan despite different politics. They forgot Black Monday in 1987 when the market dropped 22% in one day. There goes the magic of Democrats and Republicans working well together.

As for the European debt crisis, it has been an ongoing saga. Between April 2010 and July 2010, the market went down 17% ostensibly because of that. Then, between July 2010 and April 2011, the market went up 33% before the recent downturn. What happened to the debt crisis during that time?

I think a more plausible answer lies in the research of Yale professor Robert Shiller and Harvard professor, former Treasury secretary. Larry Summers. Shiller found that stock prices are 13 times more volatile than discounted dividend streams. Summers found that stock prices are 3 times more volatile than can be explained by the news. I speculate that much of the current market conundrum is caused by fear, not real economic deterioration.

Why so much fear?

The 1929 crash that ushered in the Great Depression happened in October, so did Black Monday in 1987. Unable to understand how market crashes happen, investors associate them with October. If you Google “market crash October,” you will find 59,000,000 results, including the history of real market crashes as well as near annual predictions of imaginative crashes. Investors are afraid of October, period.

But October is not the worst month for stocks; that distinction belongs to September. That makes sense; many fearful investors sell out in September.

Now that we are in October, I expect investors will see light at the end of the tunnel sometime in the middle of the month. That day, I believe, will be the market inflection point.

Warren Buffett once said:

Short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.

I just gave you some poison. Take it at your own risk.

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