Can a Fed Rate Cut Break the Stock Market's 'September Curse'?

September has long held a dubious reputation in financial circles, widely known as the historically weakest month for the US stock market. This ingrained perception is backed by decades of factual data. However, there's cautious optimism this year that this seasonal pattern might be challenged. The primary reason is the potential for Federal Reserve (also known as the US central bank) policymakers to cut interest rates at their upcoming meeting.

As stated by Nathaniel Welnhofer, a strategist at Bloomberg Intelligence, "Expectations for a Fed rate cut later this month could help to turn the tide. Historically, September returns have been higher when rate cuts occur in a non-recessionary environment."

Historical data supports this assertion. Since 1971, the S&P 500 Index (SPX) has declined by an average of 1% in September. However, in months when the Fed has cut interest rates outside of an economic recession, the index has risen by an average of 1.2%. For instance, in 2019, when the Federal Reserve lowered interest rates, the S&P 500 climbed by 1.7% in September. Similarly, during the rate-cutting cycle in 1995, the index saw a notable 4% increase that month. In contrast, when rate cuts are implemented in response to an economic recession, the S&P 500 tends to decline in September, as evidenced by its 9.1% drop during the 2008 financial crisis.

Historical S&P 500 Performance with Fed Rate Cuts

The average return on the S&P 500 is usually positive when the Fed engages in rate cuts outside of recessionary circumstances.

The latest jobs data released on Friday, revealing a significant slowdown in US nonfarm payroll growth in August and a rise in the unemployment rate to its highest level since 2021, has reinforced expectations that the Federal Reserve will be inclined to cut interest rates in September. Federal Reserve Chairman Jerome Powell had already hinted at the possibility of rate cuts at the annual Jackson Hole central banking symposium at the end of August.

Potential Challenges and Risks

Despite the heightened expectations for rate cuts, the US stock market still faces numerous challenges. The S&P 500's valuation has reached historical highs, with a forward price-to-earnings ratio of 22 times. The slowing job market suggests potential weakening economic momentum. Additionally, the impact of US tariff policies on corporate earnings remains uncertain. Furthermore, the heavy concentration in artificial intelligence-related technology stocks makes the market vulnerable to shocks tied to a single theme. Finally, the inflation rate remains above the Fed's 2% target.

Traditional pressures that markets face in September continue to weigh. Pension funds and mutual funds rebalance their portfolios at the end of the quarter. Retail investors reduce their buying activity. And companies temporarily halt stock buybacks ahead of third-quarter earnings reports.

Wall Street analysts are sharply divided on whether the 'September curse' will repeat this year. Alexander Altmann, the global head of equity strategy at Barclays, points out that the S&P 500's average 0.65% decline in September over the past 20 years has been skewed by the extreme circumstances of the 2008 financial crisis and the aggressive interest rate tightening in 2022. Excluding these events, the S&P 500 has risen by an average of 0.3% in September. He argues that a bearish view based solely on seasonal factors is somewhat overstated.

Aaron Nordvik, the head of equity macro strategy at UBS, cautions that inflationary pressures still limit how aggressively the Fed can cut interest rates. He says, "While the latest jobs data increases the probability of a rate cut, it isn't an ideal positive signal."

Paisley Nardini, the head of multi-asset solutions at asset management firm Simplify, warns that job declines could signal weakening consumer spending and a recession, and that a rate cut is merely a 'band-aid'.

In summary, while expectations of a Fed rate cut offer support to the US stock market, markets must remain vigilant for potential variables such as inflation data, corporate earnings prospects, and geopolitical risks. As Altmann puts it, "September's seasonal weakness is not insurmountable, but if external shocks combine with internal vulnerabilities, market volatility could intensify."