Is the October effect real?

October has a bad reputation in the stock markets. Is the tenth month’s infamy deserved or is it feared for no reason?

“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 had a sense of humour about everything, and that includes the stock markets as these words from his 1894 novel Pudd’nhead Wilson prove.

But the markets don’t joke. Least of all about money.

And so the “October effect” was born.

October’s the month investors figuratively hold their breath, only to breathe out and relax again in November.

In fairness, October doesn’t get its bad reputation from a few satirical lines in a 19th century book.

The stock market’s most painful memories suspiciously often took place in the tenth month of the year.

“J’accuse!” Twain’s contemporary Émile Zola would say.

But with another 23 October trading days lying before us starting Monday, let’s give the month a fair trial before we officially declare it the worst month for stocks.

What’s wrong with October?

The October effect is a real thing.

Well, it’s real in the sense that someone thought up a theory which says stocks tend to decline during the month of October and there are people who believe it.

It might not be completely irrational.

If you browse through the black pages of stock market history, you’ll find they often date back to some day in October:

16 October 1907. The Panic of 1907 saw pretty much everything you don’t want to see. A market panic led to a run on banks and the New York Stock Exchange fell nearly 50% from its peak the previous year.

28 October 1929. The day we now refer to as “Black Monday”. Yes, that Wall Street crash that would lead to the Great Depression.

19 October 1987. Black Monday, the sequel. The Dow Jones dropped 22.6% in a single trading day. It was its worst ever daily loss.

More recently, in October 2008, the S&P 500 saw about a fifth of its value go up in smoke, shortly after investment bank Lehman Brothers had kicked off the drama.

October’s record doesn’t look good. Could it be that the month really has a freaky effect on the markets?

Trading is, for an important part, mob psychology. And there seems to be some evidence that people’s moods change in autumn.

When the days grow shorter and the nights grow longer, people could be losing their appetite for risk.

“Investors might be more prone to worry this time of year,” writes Jason Zweig in the Wall Street Journal.

“Researchers have found in numerous independent studies that as summer fades into fall, people’s behaviour does turn with the leaves.

“As the hours of daylight dwindle, brain chemistry can change, reshaping how much risk some people are willing to take.”

Maybe October really is a peculiarly dangerous month to speculate in stocks then…

Satire is eating itself.

In defence of October

The Panic of 1907, the Great Depression, the horrible losses of 2008…

The evidence is pretty damning. What does October have to say for itself?

Actually, October has some compelling evidence that speaks in its favour.

Since 2002, October has had an average return of 1.6% in the US stock market. In 2011 the market went up 11%, in 2015 October saw a 7% gain.

In fact, traditionally feared October has historically delivered positive returns on stocks, on average 0.8% in the UK and 0.91% in the US.

To speak about its good character, October calls Investopedia to the stand:

“From a historical perspective, October has marked the end of more bear markets than it has acted as the beginning.”

So why are investors bad-mouthing October?

Blame the “availability bias”.

People consider something more likely if we can easily recall powerful examples of it.

If two people close to you have just had car accidents, you’re likely to think the roads are becoming less safe even though statistically that may not be true.

The “proof” of those two readily available examples has a bigger impact on the mind than some obscure statistics that might say something different.

The same could be the case with the October effect…

Statistics don’t seem to back up that October is a particularly bad month for stocks, based on average returns anyway.

But what good are statistics when investors’ minds immediately go to the losses they suffered in October ‘08?

The losses of 2008 made a much bigger impact than the 11% gain of 2011 or the 7% gain of 2015.

From 1834 through 2018, there’s only one month whose average return in the US stock market is negative, -0.4% to be exact.

It just so happens the same month also had the lowest average return for the FTSE 100 between 1984 and 2014, at -0.93%.

And that month is… September.

So as it turns out, it’s not October but September that’s the worst month for stocks!

The defendant is acquitted.

Fortunately, we only need to suffer a few more hours of September before we’re in the clear for another year.

Of course, there are still those other dangerous months for stocks to worry about.

Most notably…

April, February, May, November, July, January, August, December, March, June and October.

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