What’s Wrong With October?

This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, Editor FNArena

Popular delusions. The share market is full of them, as are most other financial markets, by the way. Remember "So goes January, so goes the year"?

We haven't heard much about that piece of colloquial "wisdom" lately, despite January providing investors with a positive signal at the start of the year. Could this be related to the fact that most equity markets are lower for the year and we have yet to find out how September and October -the two most feared months on the calendar- are going to impact on global equities?

So far we're down for September, and in Australia we're also significantly down for the year thus far (-14%). As the world is commemorating the demise of Lehman Brothers, now three years ago, which triggered one of the most savage sell-offs ever witnessed  the following month in October 2008, should investors be worried about what next month might bring? After all, there's plenty of risk material around these days, starting with a potential recession in the US and disintegration of the eurozone?

The month October has a fearsome image amongst investors. One quick look at the twentieth century immediately reveals where those fears stem from; October has hosted some of the better known, savage market sell-offs over the past one hundred and four years.

It was in October 1907 that the US experienced a run on the banks coupled with panic in the stock market. A consortium led by John Pierpont Morgan at the time brought calm and stability, effectively operating similar to the Federal Reserve today (there was as yet no Federal Reserve back then).

In October 1929 the great bull market of the 1920s came to an abrupt end with US equities dropping 23% over two days. 59 years later, in October 1987, Black Monday saw a 22% sell-off on one single day. And then, of course, there was that dreadful month post the Lehman collapse when markets froze and authorities had yet to act decisively. At one point during that month, US equities were down by 27% for the month.  In Australia, the ASX200 index had just fallen through the 5000 level in late September. By late October it had barely scrambled back above 4000. A few weeks later it was solidly below 4000.

With such a track record, it is no wonder the mentioning of October usually puts fear into an investors' mind, especially when combined with September, the month carrying the dubious label of worst month for the year in terms of average historical returns. Actually, September's historical performance is negative so it is not difficult to fathom where investors' discomfort comes from this time of the year.

However, look beyond these historical crashes (while of historic proportions each, there's only four of them, in 104 years) and a different picture emerges for the month October, one that often sees equities bottoming at the end of a tough ride, and rallying instead. Indeed, while October is never mentioned in terms of "bull markets" or "rallies", history shows the month has a solid track record for starting both, which raises the obvious question: why are we so afraid of October because of a few negative events, while the overall balance is merely positive?

Historic data show October delivers a positive return about two out of every three years. History also shows weak September performances are often followed by equities reaching a bottom in October, followed by rallies higher. As such, October is in some circles known as the "Bear Breaker"; the month has a track record for finding a bottom and setting equities up for solid rallies higher. For example, after Black Monday in 1987 investors would have done well buying into a significantly weaker share market. Similar conclusions can be drawn from October experiences in 1990 and 2001.

What about in more recent times?

To refresh everyone's memory, including mine, I have lined up the various September-October experiences between 2002 and 2010:

2002: Sep = sell off, Oct = bottom, shares end month higher, Nov + Dec = sideways

2003: Sep = sell off, Oct = bottom + rally, Nov = sell-off, Dec = rally

2004: Sep = gains, Oct = further gains, Nov + Dec = further gains

2005: Sep = rally, Oct = sell-off, Nov = rally, Dec = rally

2006: Sep = volatile, Oct = rally, Nov = pause, Dec = rally

2007: Sep = rally, Oct = volatile but higher, Nov = sell-off, Dec = sell-off

2008: Sep = pause, Oct = sell-off, Nov = more weakness, Dec = pause

2009: Sep = rally, Oct = sell-off-rally-sell-off, by month's end weaker, Nov = volatile but higher, Dec = rally

2010: Sep = volatile but higher, Oct = volatile but higher, Nov = sell-off, Dec = rally

A few obvious observations can be drawn:

1. Six positive performances have been offset by three negative performances which is in line with longer term average data: two out of every three years tend to be positive. It has to be acknowledged though, the past four years saw two negative performances and two volatile performances, so maybe the times of simply witnessing a rally taking off in October are no longer upon us?

2. September appears to be acting as an opposite indicator; a weak September tends to be followed up by a positive October and vice versa.

3. It would appear, on the basis of the experiences of the past nine years, that investors might have to worry more about what might happen in November instead of October?

Below is the 2002 chart which comes closest to October's "typical" offset of a weak September month. The second and third charts are from 2009 and 2010 when the traditional pattern is nowhere near to be found. (I will post the other seven charts in a separate news story on the website tomorrow):

As far as seasonalities go, I personally prefer April which, year-in-year-out, tends to mark a decisive change in the underlying trend for various assets. Both this year and in 2010 April put a stop to uptrends for crude oil, base metals and for global equities. No wonder as to why analysts are nowadays talking about how accurate "Sell in May and go away" has proved two years in a row.

(This story was written on Monday 19th September, 2011. It was published in the form of an email to paying subscribers on that day).

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