November 2018 Monthly Insight: The October Effect

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Nov 1, 2018


“October: This is one of the peculiarly dangerous months to speculate in stocks.

The others are July, January, September, April, November, May, March, June, December, August and February.”

—Mark Twain

Finally, the month of October is over.  What is it about the month of October?  The stock market crash in October 1929 ushered in the Great Depression.  On Black Monday, October 19, 1987, the S&P 500 Index lost 20.5%, although an economic calamity did not ensue.  During October 2008, the S&P 500 Index lost nearly 17%, the biggest monthly decline of the financial crisis.  This October’s nearly 7.0% drop is the largest monthly decline in over seven years.  Even the lesser-known Panic of 1907, which shaved 15% off the Dow Jones Industrials, was in October. 

Why does this happen in October? There isn’t a specific catalyst.  When investors place sell orders, there isn’t a “reason to sell” on the ticket.  But, we can reflect on the various themes that cast a shadow on shares.

     1. Interest rates and a policy mistake

The Fed has hiked rates eight times in almost three years and stocks performed admirably, because the rate increases were in response to a firmer economy.  Now, we are only three rate hikes away from a neutral rate, using the Fed’s own estimate.

The fear? Raise rates too quickly and the Fed risks throwing the economy into a recession.  It would amount to a policy mistake.  Raise rates too slowly, and there is a risk of overheating that may lead to inflation and eventually a bust.  The Fed’s gradual approach is designed to thread the needle.  Even though the direction of rates may matter, the level remains low.

     2. Slowing global growth and trade tensions

China is slowing down and growth in Europe has softened.  For firms doing a significant share of business overseas, the profit outlook has dimmed.  But, as investors look ahead to 2019, they are once again fretting about the impact of U.S. trade policy on earnings.  Q3 profits have been quite strong—up 26.2% through November 1.  Yet, commentary regarding tariffs injected a cautious tone into sentiment.  It’s especially acute for industrials that rely on China’s market.  Simply put, concerns bubbled to the surface that benefits from deregulation and the tax cuts might be offset by a trade war. 

     3. The so-called October effect

Let’s revisit the initial question—what is it about the month of October? On September 21, Jason Zweig wrote in the Wall Street Journal, “Investors’ fear of September and October is based less on evidence and more on what psychologists call ‘availability’—the human tendency to judge how likely an event is by how easily we can recall vivid examples of it.”  In other words, dramatic sell-offs are seared into our memories.  As a result, we don’t tend to recall the S&P 500’s eight-percent advance in October 2015.

There may or may not be reasonable explanations for the so-called October effect.  Such explanations aren’t rooted in the economic fundamentals, but rather in the behavioral aspects of investors.  It’s why we repeatedly emphasize the importance of adhering to the investment plan.  It is a long-term roadmap that takes unexpected sell-offs into account.  It places a barrier in front of an inappropriate emotional response.

Final tally and perspective

With all the angst we’ve seen in the financial press, this year the S&P 500 lost 9.9% from closing peak to trough.  It’s not quite an official correction, which would be a loss of 10%.  While we understand the speed of the pullback may be disquieting, a sell-off of 5% – 10% is modest by historical standards.  Since 1980, the average intra-year peak-to-trough dip has been 14%.  Yet, stocks are much higher today than when Ronald Reagan became President.  Why?  Stocks have a long-term upward bias with average annual gain, including dividends, of 12.6% since 1980.

We’ve experienced several sell-offs in recent years.  Pick any crises du jour—Brexit, the European debt crisis, China worries, the Ebola scare, the Japan earthquake/tsunami/nuclear disaster, U.S. debt downgrade, and much more.  Early 2016 comes to mind, when oil prices collapsed, turmoil appeared in credit markets, and recession fears surfaced.  Today, credit markets are functioning normally, the outlook for the U.S. economy is favorable, and odds of a near-term recession remain low.

We hope you’ve found this review to be educational and helpful.  If you have any questions or concerns about your financial plan, goals, and objectives or your portfolio allocation to support those goals and objectives, let’s talk.  That’s what we’re here for.

As always, we are honored and humbled you have given us the opportunity to serve as your financial advisor.