Lower returns attributable to traders being collectively ‘less attentive’ during vacations
It’s no secret September is a terrible month for stocks. According to a Wall Street Journal analysis, it’s the only month that shows average declines over the past 20, 50, and 100 years. But while the “September Effect” is widely known, no one has come up with a plausible explanation for what causes it.
Enter new research by MIT Sloan School of Management Visiting Prof. Lily Fang. She proposes a simple explanation for the September swoon: school vacations.
“What we see in September reflects a broader ‘after holiday effect’ whereby market returns after major holidays are significantly lower than at other times,” she says. “The lower returns are exacerbated in September because during the long-duration school holiday that precedes it—summer—professional investors are collectively less focused on news and as a result, information is incorporated into stock prices more slowly.”
This effect is particularly strong for negative information because taking advantage of negative news by, for instance, short-selling, is more difficult and requires close attention—a scarce resource in July and August. “Think about how traders spend their summers. They’re on the beach with their kids. They’re traveling overseas with their friends. They’re rightfully enjoying the holidays and as a result not paying as much attention to market news,” she says. “This means that news released during the holidays gets incorporated into prices more slowly than other times. And after holidays, we see that delayed reaction. It is on average negative because bad news travels slowly. It is more difficult, and requires even more attention, to take advantage of bad news than good news.”
Fang and her colleagues—Chunmei Lin at Erasmus University and Yuping Shao at National University of Singapore—compiled and examined school holiday data from 47 countries around the world. They discovered a striking pattern: returns are on average 1% lower in the months after major school holidays. Importantly, this lower return was not driven by September alone, even though the September effect is pervasive in the northern hemisphere. Even when September is excluded, there is still a return gap of at least 0.5% between after-holiday months and other times, and the difference remains highly significant.
To determine whether this disparity is indeed an “after holiday effect” rather than a spurious result, the researchers conducted a number of validation tests that exploit variations in school calendars. For example, in many states in the US, the school year starts in September; but in some southern states, the school year begins in early August. For stocks headquartered in these states, Fang’s team found that August, rather than September, exhibits especially low returns.
“The main lesson here is that attention is a limited resource,” says Fang. “We make the unrealistic assumption that since traders are professional investors, they are super machines with infinite attention spans. But the fact is: human beings are human beings.”
The Nobel Prize winning economist Daniel Kahneman wrote that: “attention is a scarce cognitive resource,” she adds. “Our research clearly speaks to that and shows professional investors are not immune. If anything, our study demonstrates the importance of professional investors in maintaining the efficiency of the markets and in the so-called ‘price discovery’ process.”
* School Holidays and Stock Market Seasonality; Lily Fang, INSEAD and MIT Sloan School of Management, Chunmei Lin, Erasmus University, and Yuping Shao National University of Singapore
Lily Fang is Visiting Associate Professor of Finance at MIT Sloan School of Management