Ric Komarek, CFP
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Shake Off a Spooky October

11/2/2018

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What is it about the month of October? The stock market crash of 1929 ushered in the Great Depression.
 
Black Monday 1987, also October, was driven by computer trading and portfolio insurance, though 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 (St. Louis Federal Reserve).
 
There is the lesser-known Panic of 1907, which shaved 15% off the Dow Jones Industrials during…yes, October (St. Louis Federal Reserve).
 
Despite its ghoulish reputation, if we look back as far as 1970, the broad-based index of 500 major U.S. stocks has averaged a gain in October. October ranks number three in performance when using the median return.
 
In case you’re wondering, September is the weakest month, on average.
 
Between 2009 and 2017, we’ve experienced three declines in October, each losing just under 2%. In the six periods that saw an advance, the S&P 500 averaged a 5.3% advance–impressive.
 
This year was different. The Dow lost 5.1%, and the S&P 500 Index gave up 6.9% (WSJ).
 
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
 
October started on a soft footing after Fed Chief Jerome Powell said the fed funds rate is “…a long way from neutral at this point (where rates neither stimulate nor restrict growth), probably” (Q&A with Judy Woodruff PBS anchor).
 
It’s a curious remark. 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. Besides, we are only three rate hikes away from neutral using the Fed’s own estimate.
 
Still, his remark suggested a more aggressive posture might be brewing inside the Fed. He has not clarified.
 
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. You know, an economic boom ensues that may lead to inflation and eventually a bust.
 
The Fed’s gradual approach is designed to thread the needle. While 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 (Refinitiv, formerly Thomson Reuters, 70% of S&P 500 firms reported). 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. But, we don’t recall the S&P 500’s eight percent advance in October 2015.
 
Zweig adds, “Average returns on U.S. Treasuries appear to be higher in fall than in spring, suggesting that investors seek safety in the darker months. Stock analysts’ earnings forecasts are less optimistic in fall and winter than in spring and summer.”
 
We receive even less sunlight in November and December! But the final two months of the year historically finishes strong, at least on average.
 
These may or may not be reasonable explanations for the so-called October effect. Such explanations aren’t rooted in the economic fundamentals but in the behavioral aspects of investors.  
 
It’s why I 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 emotional response.
 
Final tally and perspective
 
With all the angst we’ve seen in the financial press, the S&P 500 lost 9.9% from closing peak to trough (St. Louis Fed 9/20-10/29).  It’s not quite an official correction, which would be a loss of 10%.
 
While I 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% (LPL Research). Yet, stocks are much higher today than when Ronald Reagan became President. Why? Stocks have a long-term upward bias–average annual gain, including dividends, 12.6% since 1980.
 
We’ve experienced several sell-offs in recent years. Blame Brexit, the European debt crisis, China worries, the Ebola scare, the Japan earthquake/tsunami/nuclear disaster, U.S. debt downgrade, and much more.
 
When the risks that jolted short-term traders failed to materially alter the economic outlook, stocks recovered.
 
We’ve had growth scares before, and they occurred when activity was not as robust as today. Early 2016 comes to mind, when oil prices had 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.
 
If you have any questions, thoughts or concerns, let’s talk.
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