Get Ready for a Crazy October?
October looms large in U.S. stock market lore. Yet there’s only one way the month lives up to its outsized reputation: It really is particularly volatile.
Before I summarize the historical data supporting this reputation, let me first dispel two Wall Street stories about October that turn out to be myths.
Myth #1: October is the month with the most major trend changes
This is simply not true. According to the bull and bear market calendar back to 1900 maintained by Ned Davis Research, nine changes to the U.S. market’s major trend occurred in October. September comes in higher with 10, while November is tied with October at nine.
The average number of trend changes across all months is between six and seven. None of these three months’ totals differs from the average to a statistically significant extent.
The source of this myth may be a related belief that October is a so-called “bear killer.” It is true that an above-average number of bear markets in the Ned Davis Research calendar did come to an end during October: eight, versus an all-month average of between three and four. But this historical factoid sheds no light on the U.S. stock market in October of this year, unless you think stocks are already in a bear market.
To be sure, the stock market could nevertheless experience a trend change this October. But if it does, it won’t be because it is the 10th month of the year.
This is important to keep in mind because it’s human nature to ascribe meaning to random events. For example, I argued a month ago that there was no good reason to expect September to be a bad month for the U.S. market. My argument still stands, even though the month did turn out to be rough for stocks, with the S&P 500 shedding 4.8%.
If I told you that there’s no reason to expect a coin flip to come up heads, you wouldn’t conclude I was wrong even if the coin nevertheless did produce a heads. The same principle applies here.
Myth #2: October is the end of the 6-month seasonally unfavorable period
Actually this isn’t totally a myth. It’s just true in only one of every four years, and 2021 is not one of them.
I’m referring to the famous six-months-on, six-months-off seasonal pattern that goes by the names “Sell In May and Go Away” and the “Halloween Indicator.” As I’ve written before, this pattern’s statistical support traces to the third year of the so-called presidential election year cycle.
The third year of the presidential cycle so dominates the “Sell In May and Go Away” pattern that, upon focusing only on the other three years, there is no statistically significant difference between the average May-through-October and November-through-April returns. The underlying data is summarized in the table below, based on the Dow Jones Industrial Average back to its creation in 1896.
Keep this in mind this month when you hear investment advisers trying to pinpoint the day in October in which it is best to jump the gun on the official beginning of the seasonally-favorable period — Halloween. In reality, because there is no seasonal pattern beginning in November, there is nothing to get a jump on.
October is a particularly volatile month for stocks
Having dispensed with these two myths, we can focus on what is true about October: It’s he most volatile month of the calendar, as you can see from the chart below:
I’m not aware of any theoretical explanation for why October should be so volatile, and would normally recommend ignoring any pattern for which such an explanation is missing. But because higher volatility can be caused by nothing more than the expectation of higher volatility, there’s a good possibility that October’s reputation for volatility may persist.
There are a couple of investment takeaways. The first is not to let yourself be spooked by the increased volatility. Hold on tight and don’t get thrown off of your investment strategy.
Second, for those of you with a high appetite for risk, might be to take a position in one or more of the exchange-traded funds that rise when volatility spikes. The one with the greatest assets under management is the iPath S&P 500 VIX Short-Term Futures ETN (VXX). Note carefully that this product (and other exchange-traded products that profit from volatility) is suitable for very short-term trades only, since these investments lose a small amount every day even when volatility stays constant.
Mark Twain once famously said: “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.”
I don't know what to make of the October effect, let's see how this week ended.
Jesse Pound and Yun Li of CNBC report that the Dow climbs 480 points, Nasdaq snaps five-day losing streak as stocks rebound to start October:
U.S. stocks pushed higher on Friday as investors shook off a rough September and news of a new oral treatment for Covid-19 boosted shares of companies tied to the economic recovery.
The Dow Jones Industrial Average climbed 482.54 points, or 1.43%, to close at 34,326.46. The S&P 500 rose nearly 1.2% to 4,357.04, while the tech-heavy Nasdaq Composite gained 0.8% to 14,566.70 and snapped a five-day losing streak.
Shares of Dow member Merck jumped close to 8.4% after the drug maker and Ridgeback Biotherapeutics said their oral antiviral treatment for Covid-19 reduced the risk of hospitalization or death by 50% for patients with mild or moderate cases. The companies plan to seek emergency authorization for the treatment.
The new drug from Merck appeared to boost travel stocks. Shares of Royal Caribbean and Las Vegas Sands added 3.8% and 4.3%, respectively. Southwest Airlines rose 5.6% after JPMorgan upgraded the stock and said most of the group was worth buying for a trade. Bank stocks rose as well, helping the Dow outperform.
“We have seen this rotation back to the so-called reopening plays and the more cyclical areas, which I think makes a lot of sense over the next couple of weeks as we think about the Covid trends improving, with the cases falling from last month’s peak, and the news about the Merck pill appears promising,” said Angelo Kourkafas, an investment strategist at Edward Jones.
Vaccine stocks, including Moderna, pulled back following the Merck news.
Friday’s market rebound came after Wall Street capped a tumultuous September as inflation fears, slowing growth and rising rates kept investors on edge. The S&P 500 finished the month down 4.8%, breaking a seven-month winning streak. The Dow and the Nasdaq Composite fell 4.3% and 5.3%, respectively, suffering their worst months of the year.
“A combination of slowing growth, less accommodative monetary policy, China headwinds, fading fiscal stimulus, and nagging supply chain bottlenecks all conspired to weigh on investor sentiment as we head into fall and 4Q21,” Chris Hussey, a managing director at Goldman Sachs, said in a note.
Ten of the 11 S&P 500 sectors suffered losses in September, led to the downside by a 7.4% monthly drop in materials stocks. Energy is the best performer of the month, gaining more than 9%.
The 10-year Treasury yield fell back below 1.50% on Friday. A jump in rates to end September knocked tech stocks.
The S&P ended Thursday 5.2% below its all-time high reached in early September, the first 5% pullback of 2021. Even with Friday’s rally, the index fell 2.2% for the week. The Dow and Nasdaq lost close to 1.4% and 3.2%, respectively.
The S&P 500 is still up roughly 16% on the year, however.
“That’s just a squiggle. As we zoom out, it’s going to look like nothing in 12 months. I know investors are nervous, and there’s a lot of headwinds here, but as you know, when the wall of worry is big, that’s often a good opportunity for investors,” Fundstrat’s Tom Lee said on CNBC’s “Halftime Report.”
While October is known for notable market crashes, it typically is the start of a better seasonal period for stocks. The S&P 500 averages a 0.8% gain in October, according to the Stock Trader’s Almanac. Stocks average a 1.6% increase and 1.5% rise in November and December, respectively, according to the almanac.
On the data front, personal income rose 0.2% in August, in line with expectations. The price index for core personal consumption expenditures was up 3.6% year over year, the biggest jump in more than 30 years slightly ahead of the estimate of 3.5% from economists surveyed by Dow Jones.
In Washington, President Joe Biden went to Capitol Hill on Friday to try to help in negotiations over a major infrastructure bill. Congress reached a short-term deal to fund the government on Thursday but is still working on legislation on infrastructure and the debt ceiling.
I am paying attention to whether Congress can reach a deal on the infrastructure bill.
The House on Friday tried to reach a deal on a pending infrastructure bill, but that won't be soon enough to avoid furloughs for thousands of employees at the Transportation Department who were not covered by a funding bill Congress passed earlier this week.
Fiscal retrenchment, monetary retrenchment, that just spells more volatility for stocks.
In his latest report, Francois Trahan of Trahan Macro Research writes this:
The recovery in cyclicality is finally upon us. Indeed, proxies of risk like beta, smaller size, or even value stocks have all performed better in recent weeks. This is a sign that the ISM and other PMIs are probably going to be higher for the month of September when they are reported next week. Moreover, anticipatory indicators argue that better readings in these series could last a few months before we finally embark on a prolonged downturn in 2022.
We would use this opportunity to position portfolios for the coming macro trends: a unique blend of lower PMIs and Fed tightening as we highlighted in last week's report. Interestingly, Fed comments in recent days seem to suggest that this scenario is not as far-fetched as it appeared just a week ago.
The focal point of our work in recent weeks has been about positioning for this unusual macro combination. More specifically, we focused on how this would lead to a different set of market leaders than the investment playbook suggests following a peak in PMIs. This week, we examine the implications of this backdrop on the stock market itself. Will the S&P 500 hold up as it typically does following a peak in PMIs? Or, is the outlook for the major indices also at odds with the traditional playbook? History holds some interesting surprises in this regard.
Make sure you read Francois’s latest report on the Fed as the single greatest threat to US equities.
Below, I provide you with just the first page, it's excellent:
The Fed should be everyone's concern here because if it starts tapering, we will see a significant pullback in risk assets.
In his weekly market wrap-up on mid-cycle dynamics, Martin Roberge of Canaccord looks at the commodity cycle and writes this:
Our focus this week is on commodities and ongoing supply bottlenecks. The inventory re-stocking cycle which started in Q3/2020 is maturing but supply issues continue to hinder restocking efforts by retailers, wholesalers and manufacturers. The ISM mfg. PMI release this morning confirms this view, with the new orders (NO) component coming in at 66.7 and customer inventories (IV) at 31.7. As we show in our Chart of the Week, the NO-IV spread remains comfortably above 30pts, a level last seen in 2003 and 2009 following the 2001 and 2008-09 recessions. Looking ahead, as the pandemic recedes, supply constraints should ease gradually, confirming the transition from early cycle to mid-cycle. This is when economic growth usually embarks on a more sustainable path, as opposed to the typical snap-back following recessions during the early phase. At this point, we believe it would be normal and even desirable for the NO-IV spread to ease a bit. Importantly, commodities tend to continue their advance during the transition from early- to mid-cycle dynamics. As such, our pecking order remains unchanged, with commodities (OW) > stocks (UW) > bonds (UW).
I agree on the supply bottlenecks and if you look at energy in particular, there's no investment whatsoever, which can bolster energy stocks a lot higher from here:
We shall see but if the Fed starts ruining the party, it will impact all risk assets, cyclical sectors and growth sectors will get hit.
That's all from me, I don't have time to really get into markets this week, will discuss more next week.
Below, "I know September was an ugly month," Tom Lee, Fundstrat's managing partner tells Scott Wapner on the Halftime Report, but he still believes there will be record highs in the market by year-end.
And earlier today, Jim Cramer and Fundstrat's Tom Lee joined the Halftime Report to discuss the markets and the impact of supply chain challenges and dysfunction in Washington.