October is a unique month. In the west, October is a transitional month as autumn slides relentlessly towards winter. It also boasts the only holiday where people are encouraged to dress up, scare each other, and extort candy with threats of mischief.
October also has a special place in finance. Associated with the October effect, it's one of the most feared months in the financial calendar. Let's have a look at whether there's any merit behind the fear. The events that have given October a bad name span over 100 years.
- The October effect refers to the psychological anticipation that financial declines and stock market crashes are more likely to occur during this month than any other month.
- The Bank Panic of 1907, the Stock Market Crash of 1929, and Black Monday 1987 all happened during the month of October.
- Historically speaking, however, September has had more down markets than October.
- The psychological effect that causes some traders to blame October for stock market declines may actually make it one of the better buying opportunities for contrarian investors.
The Bank Panic of 1907
A financial panic threatened to engulf Wall Street, mostly owing to threats of legislative action against trusts and shrinking credit. The panic started in October 1907 and stretched for six weeks.
During this time, there were multiple bank runs and heavy panic selling at the stock exchange. All that stood between the U.S. and a serious crash was a J.P. Morgan-led consortium that did the work of the Federal Reserve before the Federal Reserve existed. The consortium provided the funds necessary to stabilize various banks and even the city of New York.
Stock Market Crash of 1929
The Crash of 1929—which began on Oct. 24—was a financial bloodletting on an unprecedented scale because so many people had money invested in the market. It left several "black" days in the history books, each with its own record-breaking market slide.
The Panic of 1907 led to the Federal Reserve Act of 1913, which established the Federal Reserve Board and the 12 Federal Reserve Banks as "lenders of last resort."
Nothing says Monday like a financial meltdown and an unexpected stock market crash. On Oct. 19, 1987—the day that historians refer to as Black Monday—automatic stop-loss orders and financial contagion gave the market a thorough throttling as a domino effect echoed across the world. The Federal Reserve and other central banks intervened and the Dow recovered from the 22% drop quite rapidly.
Taking the Blame for September
Oddly enough, September, not October, has more historical down markets. Importantly, the catalysts that set off both the 1907 panic and the 1929 crash happened in September or earlier, and the reaction was simply delayed.
In 1907, the panic nearly occurred in March and, with the tension building over the fate of trust companies, could have happened in almost any month. The 1929 crash arguably began when the Fed banned margin-trading loans in February and cranked up interest rates.
Taken as a whole, a very strong argument can be made for September being worse for the markets than October, as you can see below from the number of "Black Days" occurring in the month.
The Original "Black Day"
Most Americans associate Black Friday with the day after the Thanksgiving holiday, when retailers offer huge discounts and consumers kick off their holiday shopping. But the original Black Friday on September 24, 1869 was anything but festive. Jay Gould and other speculators tried to corner the gold market, working with an insider at the Treasury. The price kept rising until the Treasury broke the corner by selling $4 million in government gold, dropping the price of gold by $25 in a single day, sparking a catastrophic crash, and ruining many speculators.
Black Wednesday occurred on September 16, 1992, with George Soros' raid on the British pound. This September event is considered infamous by people outside the forex community. Within the forex community, however, it's revered as one of the greatest trades ever made. Soros reportedly made a $1 billion profit on the deal, but the British government lost billions trying to shore up its currency leading up to the eventual capitulation.
September 2001 and 2008
The single-day point declines in the Dow that occurred during September 2001 and 2008 were bigger than that on Black Monday 1987. The first resulted from the attacks on the World Trade Center. The second was tied to the subprime mortgage meltdown. The 2008 plunge involved far more than the U.S. economy, trimming $1.2 trillion from the global economy in a day.
An Angel in Disguise
Surprisingly, October has historically heralded the end of more bear markets than the beginning. The fact that it is viewed negatively may actually make it one of the better buying opportunities for contrarians.
Market slides in 1987, 1990, 2001, and 2002 turned around in October and began long-term rallies. In particular, Black Monday 1987 was one of the great buying opportunities of the last 50 years.
Peter Lynch, among others, took this opportunity to load up on solid companies that he'd missed on their way up. When the market recovered, many of these stocks shot up to their previous valuations and a select few went far beyond.
October Effect Unjustified
October gets a bad rap in finance, primarily because so many black days fall in this month. This is a psychological effect rather than anything to blame on October. The majority of investors have lived through more bad Septembers than Octobers, but the real point is that financial events don't cluster at any given point.
The worst events of the 2008–2009 financial meltdown happened in the spring with the collapse of Lehman Brothers. Stocks tend to fall in November and December due to year-end rebalancing and tax optimization (e.g., tax-loss harvesting or charitable donations). Some financially damaging events haven't been given black day status simply because the media didn't choose to dust off that moniker at the time.
Although it'd be nice to have financial panics and stock market crashes restrict themselves to one particular month, October is no more prone to bad times than the other 11 months of the year.
Why Do Contrarian Investors Like October?
Contrarians like the negative effect on the markets that stems from a belief that October is the worst month for stock market declines. They take advantage of the buying opportunities that can pay off once the unjustified fear abates.
Do the Media Push the Negative October Effect?
Probably to some extent. The media has always labeled events in eye-catching ways in the press, for better or for worse. Since in actuality there really is no October effect, one could say that the press helps support the belief to the contrary.
Did J.P. Morgan Help the U.S. Avert Financial Disasters?
Yes, in addition to resolving the Panic of 1907, earlier as a partner in the firm of Drexel, Morgan & Co., J.P. Morgan, along with his associates, was the nation's primary source of loans to the U.S. government. In 1895, he and other bankers were also behind the successful effort to stabilize the country's dwindling money supply during the worst depression in U.S. history at the time.
The Bottom Line
While October has had its share of disastrous stock market days, in actuality, negative financial events aren't limited to that month. It turns out, October is no more of a magnet for market collapses and the onset of crises that any other time of the year. However, the psychological influence of the "October effect" can present investors with choice investment buying opportunities that can pay off later.