How can traders best ride out the stock market in October?

The month of October signals not only the beginning of the final quarter of the year, but it also has a bit of a reputation among investors as being a volatile time of year for global stock markets.

While we’re only halfway through the month, the FTSE 100 has already fallen by 2.65%, as of 16 October. Over the same period, the S&P 500 is down by 0.6%, while the Stoxx Europe 600 and other European indices are largely flat. 

With September having been relatively calm for equity markets – the S&P 500 didn’t fall 1% on a single day throughout the month – that could be an indication that this October could attract some big swings. 

 

Macro or monthly factors?

What will ultimately influence markets this month are any major developments in the US-China trade negotiations, earnings releases – which are expected to show a third consecutive quarter of lower profits – and the UK’s 31 October Brexit deadline. 

“What has us worried this October is the fact that September [commonly known as the weakest month for stocks] this year was historically calm,” said Ryan Detrick, senior market strategist at LPL Financial said in a note to clients. “If we know one thing, it is that markets don’t stay calm forever and after a dull market last month, we could be due for some usual October volatility.”

“If we know one thing, it is that markets don’t stay calm forever and after a dull market last month, we could be due for some usual October volatility” - LPL Financial senior market strategist Ryan Detrick

 

While six of the 10 worst single-day drops have taken place in October since 1928, according to LPL Financial Research, three of the 10 best days occurred in October as well. 

While these odds appear to tilt towards October being more susceptible to a pullback than other months, it’s actually historical events that have ingrained the overall idea of it being a bad month.    

 

A spooky month 

Looking back, some of the biggest selloffs have occurred during October. The most infamous among these is the Wall Street Crash of 1929 in which stock prices plummeted over four days of trading. The crash began on 24 October, known thereafter as Black Thursday and ran until the following Tuesday, now dubbed Black Tuesday. The Dow Jones dropped nearly 25% over the period, wiping $30bn from the index’s market, exceeding the total cost of World War I and driving the US into the Great Depression. 

Another dark day for markets, Black Monday, occurred in 1987 as stocks were wracked by another crisis. Global stock markets had been experiencing intensifying declines until selling pressure hit a peak on – you guessed it – 19 October. What followed was several days of severe downturn. 

  

And these events are not a thing of the past. A more recent event occurred just last year when a worldwide selloff occurred across equities. Having lost more than $2tn in October 2018, US markets endured one of the worst months since the financial crisis. 

From these major events to the 1997 Asian Financial Crisis, otherwise known as the Asian contagion, to the 2002 tech and 2011 stock market bottoms, October can certainly be seen as a month of past wild market swings.

 

A self-fulfilling prophecy 

However, as Stock Trader’s Almanac editor-in-chief Jeff Hirsch indicates, October’s reputation as the “jinx month” may be unjustified. Research from the publication has found that over the last two decades it has in fact been the second-best performing month of the year for the S&P 500 and the Dow Jones. 

In an interview with CNBC, Hirsch describes October as “at a juncture in the market’s counter where things tend to get turned around”. Hirsch said the month attracts a lot of selloffs because it sits at the beginning of the fourth quarter, which is a time when many investors are “jockeying for position.” 

It also follows on from September, which is at the tail end of the third quarter when many investors are window dressing – a strategy used by portfolio managers to improve the appearance of a fund’s performance – and getting ready for the end of the year. 

Hirsch noted that the month also coincides with the October 31 mutual fund deadline when portfolio managers and investors have to sell positions in order to make distributions by year end.  

Furthermore, Detrick notes that over the last 20 years October has actually been the third-best month of the year for global stocks and since 1950, it ranks as the seventh strongest of the year. 

 

A tough act to follow 

Historically speaking, September has had far more frequent down markets than October, making it one of the worst performing months for the stock market, what Investopedia calls the September Effect. Looking at an analysis of market data, most often US indices indicate that September is the only calendar month with a negative return over the last 100 years.  

Indeed, the S&P 500 Index fell more than 5% in four of the 10 Septembers of the decade leading up to 2010, according to research conducted by Zacks. Furthermore, in the years when stocks advanced in September, the stock market grew nearly 2% during the month of October. 

It is not entirely surprising then that selling momentum would continue into October, as most analysts consider that the negative effect is attributable to seasonal behaviours such as investors or mutual funds changing their portfolios at the end of summer to cash in their holdings. 

 

Making sense of market anomalies

Despite the bearish concerns attached to October, it has mostly served as a reminder to investors of how quickly fortunes can reverse and at the end of the day everyone needs a down month to allow them to buy more. 

But as investors look to past stock returns to find patterns, October does appear to have shaken off its bad reputation to be a strong month, especially considering its position before December and November, which are some of the most profitable months for stocks. 

“The average return in October is positive historically, despite the record drops of 19.7% and 21.5% in 1929 and 1987,” research by Investopedia indicates. This highlights that while patterns can be discovered in past performance data, these may be nothing more than temporary coincidences. 

“The average return in October is positive historically, despite the record drops of 19.7% and 21.5% in 1929 and 1987” - Investopedia