The month of October is a scary month in the United States. It’s the month in which Halloween is celebrated — a holiday that glorifies horror movies and frightening creatures, and one in which we reward children with candy for doing nothing more than walking up to strangers in masks and asking for it.
Many investors believe there is another scary event that happens in October. It’s known as the October Effect, and the belief goes that October is a treacherous time for investors who aren’t prepared for it.
Even some investing experts advise that you be very careful when making moves in October. They say it’s the worst month of the year for investors, and that if you decide to invest in it, you should prepare for sudden losses.
Is there any truth to this notion? Has the market experienced losses more consistently in October than in other months? Let’s take a closer look.
What the Statistics Say
To find out whether the October Effect is based in truth, let’s look at historical data to see if October indeed saw more frequent or larger losses compared to any other month on average.
Staticians will tell you that to get a proper statistic, you’ll need at least 30 pieces of data. We can do much better than that thanks to decades of financial data. Here’s a breakdown of the performance of the S&P 500 by month over the past 92 years:
|Month||Years Up||Years Down||Average Monthly Returns|
Looking at this data, it’s clear that October isn’t a bad month for the stock market at all. Not only has the S&P 500 gained in the month of October more often than it has declined, but the returns for the index during the month have been positive on average during the past nine decades.
Cold, hard numbers bust the October Effect myth, but the data shows there is one month in the year that is pretty clearly the worst for investors. In the month of September, the S&P 500 has produced losses more often than gains on a historical basis. At the same time, the average return for the month of September comes in at -1%. So, perhaps September should be the month that experts position as the time to be wary of the stock market each year.
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Why September Is the Worst-Performing Month for Investors
What’s the deal? Why is September such a painful month? Experts attribute the phenomenon to three key factors:
- Profit Taking. Historically, the end of the summer has been the time for profit taking. It’s during this time that investors generally restructure their portfolios and cash in on some of the gains they’ve experienced throughout the year. While there’s no real explanation as to why the average retail investor decides to cash in at the end of the summer, historically that’s what typically takes place.
- Tax-Loss Harvesting. There’s also a trend of mutual funds cashing in in September for tax reasons. Tax-loss harvesting is a way to lighten the tax burden associated with gains throughout the year by selling off other assets that have declined. These transactions must be completed before the end of the tax year, and many large funds may begin assessing their tax situation and exiting the positions they intend to sell for tax reasons as the third quarter draws to a close in September.
- Investor Vacations. Finally, some argue that September is a huge month for vacations, and that volume is typically light as a result. With fewer investors paying attention to the stock market, there’s not as much money floating around to prop stocks up. This also pairs well with the profit-taking theory, as some argue that September is the month some investors take profits in order to enjoy more expensive vacations.
So Why Do Investors Fear October Instead?
Although the month of October is, statistically, nothing to fear, there’s a good reason why the October Effect myth has become so deeply ingrained in the minds of the investing public. The month of October happened to be the setting for some of the most painful declines in stock market history.
Although these declines have been few and far between, they were so painful that investors still remember them, leading to an overwhelming — if unsubstantiated — belief that October is the worst month for investors.
Events That Led to the October Effect Myth
There are two major events that led to the October Effect myth. The first took place in October of 1929 and the second in October of 1987.
Black Tuesday: October 29, 1929
Throughout the 1920s, the U.S. stock market experienced a prolonged expansion. That is, until late in 1929.
On Tuesday, October 29, 1929, panic set in, leading to high volumes of shares being sold and sudden, massive declines in the stock market. On that Tuesday — which came to be known as Black Tuesday — about 16 million shares were traded in a single day, marking a record at the time.
With the stock market taking such a massive hit, the U.S. economy — followed shortly by the global economy — spiralled out of control. Black Tuesday led to the deepest and longest-lasting economic downturn in history. The pain felt in the market on this fateful October day would lead to what we now know as the Great Depression, a global economic collapse that lasted about a decade.
This event would be burned in the memory of all consumers, not just investors. In a single day, thousands of investors were wiped out and billions of dollars were lost.
Black Monday: October 19, 1987
The second event that left a bad taste in investors’ mouths is known as Black Monday, which took the stock market by surprise on October 19, 1987. In a single day, the Dow Jones Industrial Average suddenly gave up 22% of its value.
That fateful Monday would mark the beginning of a global stock market decline. By the end of October, 1987, most major indexes around the world had fallen by 20% or more. Luckily, the market recovered quickly and another Great Depression was averted.
To this day, no one can pin down why Black Monday happened. Some experts attribute the declines to geopolitical unrest around the globe. Some attribute them to computerized trading, which led to an accelerated selloff.
However, no major geopolitical events took place on Black Monday or during the weekend before. And while computerized trading algorithms may be partly to blame, the volume of shares traded in this way back in 1987 was pretty minimal and simply couldn’t have led to such a sell off.
While the catalyst behind Black Monday remains a mystery, the event shocked many investors who had no way to see such a sharp decline coming. It was such a painful day for investors that it further solidified the notion that October is a bad month for the stock market.
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What Are the Best Months to Invest?
While October definitely isn’t the worst month for the stock market historically, it’s also not the best. That begs the question: “What are the best months to invest?” To find that out, take another look at the data in the chart above.
In terms of the months that most frequently ended in gains during the past 92 years, April takes the lead with 59 positive closes, followed closely by January and December, which are tied at 57 positive closes. In terms of the best average returns, April is a close runner-up, with an average return of 1.5% lagging slightly behind July’s 1.6% average return.
So why are January, December, and April the months that have ended positively most often? It may be a matter of human nature and something of a herd mentality. Regardless of fundamental data, if the overwhelming majority of investors believe a stock is going to rise in value, they start to purchase the stock, leading to a self-fulfilling prophecy of the stock price going up.
In addition, think about what these months represent and the speculation that centers around them among investors.
- January. January is the start of the new year in the United States. That in and of itself has several implications for the stock market. Companies announce their financial results for the full year prior. Companies are also likely to announce new innovations and work to build investor interest for the year to come. As such, we tend to see more buying in January than most other months.
- April. April 15 is tax day in the United States. However, most people overpay throughout the year, leading to the coveted tax refund for many taxpayers. As consumers file the paperwork for their refunds, many are already thinking of ways to spend it. Starting at the beginning of April, investors see an influx of spending power reaching the average American home in the near future, leading to expectations of growing sales and revenue for publicly traded companies. This happens at the same time many investors themselves are receiving tax refund windfalls to pour into the market.
- December. Finally, December is the peak of the holiday season in the United States. Most major religious holidays take place during this month, leading to major spending on everything from gifts to consumer staples to travel. All this consumer spending is great for publicly traded companies working to sell their products and services, once again leading to the expectation of increasing sales and revenues and investors being more willing to make new investments in the month.
The October Effect is a scary concept. However, you don’t have to worry about it. Although two very real historical events may have led to the fear of losses in October, statistically you’re more likely to realize gains when you invest in October, not losses.
Ultimately, this conclusion leads to an important lesson, specifically for beginner investors: Even the experts can be wrong.
The October Effect isn’t the only myth in the market. But it has led to investors deciding to pull money out of the market during the month, taking on losses in the form of missed opportunities for gains had they simply stayed invested.
Another key lesson here is that it’s never a good idea to follow the herd. Those who do best in the world of investing are those that do their own research.
So, the next time someone tells you October is a horrible month to invest, or June is the best time to invest, or really anything else with regard to how to invest your money, take your time to research before making moves based on their opinions.
Have you fallen for the October Effect myth? How has the myth guided your investment decisions in October?
Originally posted at https://www.moneycrashers.com/stock-market-october-effect/