Will Stocks Get Hit This September?

September got off to a rocky start yesterday as the Dow Jones Industrial Average lost 2%, stoking fears concerning what has historically been the worst month in the calendar for stocks. But just how bad could things get this year?

A short market history lesson
Using price data from Dow Jones going back to May 1896, I verified that September is indeed the worst month for the Dow on the basis of average returns. At (1.2%), it is one of only two months that can't boast a positive average return (the other is February, with a much smaller 0.2% loss). September also hosted the worst monthly performance for the Dow in history: a loss of nearly 31% in 1931.

That was then, what about now?
What can we expect this year? A month's time horizon is far too short to even begin making a serious prediction. However, according to data compiled by Professor Robert Shiller of Yale, the broader S&P 500 index is valued at nearly 18 times its cyclically-adjusted earnings (average inflation-adjusted earnings over the prior 10 years). That is a premium to the multiple's long-term historical average of 16.3, so a correction of 10% to 20% wouldn't be highly surprising in this environment.

The good news
The outlook isn't uniformly somber, though: By my calculations, every one of the Dow components is currently changing hands at a cyclically-adjusted P/E multiple below that of the S&P 500. This includes superb businesses such as:

Company	Cyclically-Adjusted P/E Multiple*
Caterpillar (NYSE: CAT  )	7.6
Exxon Mobil (NYSE: XOM  )	8.1
Walt Disney (NYSE: DIS  )	10.9
JPMorgan Chase (NYSE: JPM  )	11.7
United Technologies (NYSE: UTX  )	12.1
Microsoft (Nasdaq: MSFT  )	12.8
Cisco Systems (Nasdaq: CSCO  )	15.4

*Note that the calculation of these multiples isn't perfectly consistent with Shiller's calculation for the S&P 500.
Source: Author's calculations, based on data from Capital IQ, a division of Standard & Poor's.

The table suggests that while runaway bulls may have picked clean lower-grade stocks, prudent investors should look at a different menu -- there may be an opportunity to feast on quality stocks instead.

Jeremy Grantham's firm, GMO, is forecasting that "high-quality" U.S. stocks will beat large-cap stocks by nearly seven percentage points annually over the next seven years! Morgan Housel has identified three high-quality companies that are still cheap.