Will September Rally Fizzle? History May Offer a Clue - CNBC

Even as economic fundamentals and regulatory uncertainty line up against stocks, Wall Street does have one thing in its favor for October: History.

Despite an improbable 9 percent rally in September - historically one of the market's worst months - past trends suggest that a good performance in the month often leads to more strength in October.

There have been six occasions since 1928 when the Standard & Poor's 500 has gained more than 5 percent in September, and they have been followed by an average gain of 0.7 percent in October, according to S&P research.

And in the 14 instances in the past 30 years when the S&P has a positive September, an October gain has followed nine times, with an average rise of 1.64 percent.

While each month and each year are certainly different, stock market bulls at least have something to bolster their argument even after such an odd September rally.

"October is frequently tagged as a fearful month for investors," said Sam Stovall, chief equity strategist at S&P, in a note to clients. "One reason is because investors painted October as a 'crash' month after the Great Crash of 1929 that was reinforced by the Crash of '87."

But the perception hasn't held up. Stovall notes that since 1945 October actually has been the market's best month.

S&P, in fact, on Wednesday raised its 12-month projection for the 500 index to 1270 from 1200 due to seasonal factors and the dissipation of double-dip economic fears.

Of the three major averages, the Nasdaq tech barometer has done best during September, rising 64 percent of the time over the past 22 years, and following that up with October gains 57 percent of the time.

The Dow has fared worst, closing up only 39 percent of the time in September and then following that up with October gains in 54 percent of the time in the past 61 years.

Though the market moved sideways this past week, investors seemed to have moved away-again-from double-dip fears. Now, they're back into a mindset where as long as economic numbers beat humble expectations, that's a reason to buy.

"The market always does the opposite of what everybody expects. Everybody expected the market to sell off in September and it sells of in August instead," says Keith Springer, president of Capital Financial Advisory Services in Sacramento, Calif. "The (economic) stats aren't nearly as bad as the worst case could have been. We're in a market now where as long as it's not horrible, it's pretty good."

Investor sentiment surveys, such as those from the American Association of Individual Investors, are showing strong bullish sentiment, with nearly 43 percent of respondents indicating they think the market will go higher.

While such surveys are often contrarian indicators, that was not the case for September when optimism remained intact and so did the stock market's move higher.

"I don't think we've exhausted ourselves," says Todd Salamone, senior vice president of research at Schaeffer's Investment Research in Cincinnati. "Looking at some of the sentiment indicators over the past nine months, whether it was the options market or polls from active investment managers, they weren't anywhere near the levels that have preceded corrections. It does suggest there's firepower on the sidelines."

Money has been coming in off the sidelines at a steady pace, with $2.8 trillion parked in money market funds as of Sept. 29, according to the Investment Company Institute. That's well below the more than $4 trillion that had been out of the market during the worst of the financial crisis.

Stock allocations total 55.2 percent of investor portfolios, the highest total since April, the latest AAII numbers show.

Portfolio managers and hedge funds who missed the September rally could be tempted now to start deploying cash in hopes of playing catch-up, another factor that could continue the autumn surge.

"You have a lot of professional investors and managers that are trailing their benchmarks. September just exacerbated that move," says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "As we get closer to year-end, there definitely is a push by professional investors to chase rallies and then want to see pullbacks so they can get invested."

Yet Flam says he doesn't see strong levels of conviction either way in the market. And indeed, just four weeks ago the AAII respondents were indicating a level of bearishness not seen since just before the market found its March 2009 lows.

"At the end of the day our method of investing is longer-term," Flam says. "So we're trying to think of not necessarily what gets us to year-end but what gets us to year-end 2011. If we get that call right, because that is a bigger call, then we're going to be doing the right thing and our investors are going to be happy."