The October Effect & Modes of Decision

Beware, beware the ides of, well, of October?  Actually no, but what is it with the month of October that the spooks of Halloween give way to the worry of a market loss or even disaster in the eyes of many, so much so that it’s been given a name, the October effect? The October effect is the theory that stocks typically drop in October, and to be fair October does have some tradition in hosting memorable market dropping events: the crisis in 2008, Black Monday of 1987 fame, and let’s not forget 1929’s infamous Black Tuesday. Do these market events, disastrous as they were, give us enough to justify the ill will over October or is it as Jason Zweig wrote in The Wall Street Journal recently, “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.”

Strong market drops certainly make for strong memories that lend themselves to availability, what’s not so available is what the non-historic months actually look like. Dig past availability and what you’ll find is that October returns on average have been positive since the mid 19th century and as of 2002 October has been the third best month with returns averaging at 1.6%.

Let that sink in. Since 2002 October averages out positive, even with 2008 numbers sitting in there.

Now, while the fear may not be justified the fact that October is one of the most volatile months for the market, as clearly exhibited over the last few weeks, does nothing to belay those fears. What does work though is having a plan and sticking to it, and never ever trading on fear. Part of the plan is having solid information, such the fact that there has been a 13% drop in the market every year at some point since 1950. Knowing that allows for more patience when judging buy and sell signals, i.e. is this the start of a bear market or is this just a market correction and a buying opportunity. 

Examining past trends and cycles is vital to guiding trading decisions, but equally vital is looking further than market fluctuations to explore a more holistic look at economic health as whole. The market sometimes just moves with no real discernable reason, emotional folk do emotional things, so we follow other measures to help gauge if moves are short or long term.

These short-term moves are unnerving, but how is the economic outlook as a whole? Well, we’re actually in a pretty good spot. The unemployment rate for September 2018 was at 3.7%, it was sitting at 3.9% the previous two months. 3.9% is good in and of itself but getting down to 3.7%, that’s the lowest it has been since 1969, so promising. Another important indicator we follow is new housing starts.  That number is a little down month over month but it is sitting within the range that it has been over the last three years, in other words it is stable. There don’t look to be any wild shifts coming there in the near future.

The yield curve is another indicator that we are always watching, it is usually a leading indicator that a recession is on it’s way. The yield curve is the difference between interest rates on long and short term debt vehicles, bonds. If short term bonds are paying higher interest rates than long term bonds are that means the yield curve is inverted, and inverted yield curves indicate a potential incoming recession. At the moment the yield curve is not inverted or close to inversion.

Looking at all of this we’re able to exercise patience and let these market moves exhaust themselves before making any major moves. The volatility can make for a wild ride but unemployment rates are good, housing starts are good, and the yield curve doesn’t have us looking down the barrel of a recession. There are two other trend points, and one point of news, that have us optimistic right:

  • Typically the third year of a presidential cycle is usually the strongest year in that cycle for the markets

  • The markets have been positive after midterms every time since WWII

  • Earnings reports have been strong recently

Looking at all of this together and we are not seeing any reason for panic or selling off, in fact, signs are pointing to a healthy economy with some promising buy opportunities.