October is here: Should you be spooked?

A perspective from E*TRADE Securities2

10/12/18

It’s been a rocky week in the markets, which shouldn’t come as a total surprise. Among investment circles, October is legendary—and not necessarily for the right reasons. Known as one of the most volatile months of the year, October has witnessed some of history’s most spectacular stock market crashes as well as impressive gains.

Some analysts have questioned the validity of the so-called “October effect,” and the month is by no means a predictor of stock market volatility. But there’s just enough evidence to warrant walking around the next ladder you see instead of under it.

The big events: Past Octobers as bookmarks to history

No discussion of October can begin without looking back at some of the headline events that have burnished the month’s reputation as a nightmare on Wall Street.

1.  The panic of 1907: Theodore Roosevelt was in his second term when a financial panic broke out in October 1907—the start of a six-week stretch of bank runs following the bankruptcy of two large brokerage firms. Before there was a Federal Reserve, legendary financier J.P. Morgan came to the rescue as a modern-day Robin Hood, funneling funds from stronger institutions to weaker ones, which eventually restored calm to the financial markets.   

2.  The stock market crash of 1929: The granddaddy of them all, the crash of 1929 marked the end of the roaring ’20s and the dawn of the Great Depression. From October 24-29 of that year, investors watched helplessly as the market plunged by more than 25%. This was an era when investors had relatively few protections and buying on margin was rampant. When brokers made margin calls, borrowers couldn’t come up with the cash, causing stocks to sell off.

3.  Black Monday 1987: Following five years of outsized gains in the go-go 1980s, investors in 1987 were ill-prepared for the market crash of Monday, October 19. By the time the bloodbath was over, the Dow Jones Industrial Average had cratered by 508 points—nearly 23% in a single day. To this day, “Black Monday” remains the largest one-day stock-market drop in history (in percentage terms). To appreciate just how far stock prices have advanced in the more than 30 years since, consider that the market has dropped by more than 500 points 22 times since October 1987—including seven times in 2018 alone … so far. In fact, the Dow’s largest point-drop ever occurred just this year, on February 5. But those 1,175 points amounted to a mere 4.6% decrease in the Dow Jones Industrial Average.1

October: A black cat crossing zone

Sure, these historical events may read like horror stories, but they hardly represent a trend. Is October really the monster it’s made out to be? In reality, Octobers of late make up a witch’s brew of stock market returns—some bad, many good.

If you consider the Cboe Volatility Index® (VIX®)—a widely followed barometer of market volatility—October has historically generated the highest average monthly volatility from 1990 through 2017. 

Cboe Volatility Index, 1990-2017

Source: Cboe Global Markets, Inc.


Election jitters can rattle the markets

Why has October historically haunted investors? Although tariffs and higher interest rates loom large this year, traditionally market observers have cited a number of possible reasons, including the following month’s elections. Investors get jittery over the uncertainty of elections, so it’s no surprise that big investment decisions are made preceding November’s mid-term and presidential contests. Some also theorize that traders coming back from Labor Day vacations make sizeable bets in September, which can result in heightened volatility a month later.2

The news isn’t all a tale from the crypt

There is good news, though. While October can be as wicked as a witch ginned up on eye of newt, it is also one of the better-performing months historically. In fact, with the S&P 500® Index as a gauge, October has generated the highest monthly returns over the past 20 years, as measured by average month-over-month percentage price changes.

Source: FactSet Research Systems


Double double toil and trouble? Not with the power of compounding

Whether or not you buy into the October effect, those with a solid long-term plan have very little reason to be frightened. Investors who align their strategies with their investment horizon and risk tolerance put themselves in a position to succeed—particularly if they diversify their holdings across a broad array of equity and fixed income asset classes.

In addition, long-term investors can harness the mystical power of compounding—the snowball effect of earning future returns on past gains. The longer you keep your money invested, the greater your chances of generating capital growth—which is a lot better than a broom stick in the eye.

Ultimately, with proper positioning and a pinch of patience, it may be easier than you think to fend off the ghouls of October.

1. FactSet Research Systems, October 11, 2018

2. HBX Business Blog, “Why is October the Stock Market’s Most Volatile Month?” HBX Business Blog, September 21, 2017. https://hbx.hbs.edu/blog/post/why-is-october-the-stock-markets-most-volatile-month