- September's weakness was in line with the month's poor historical returns.
- October has an intriguing track record for returns, including in bear markets.
- Historical probabilities aren't certainties, so approach October cautiously.
There’s no shortage of reasons to worry about how stocks will perform from here. Inflation remains stuck near 40-year highs, and the Fed is ramping interest rates to crimp economic activity to lower it. As a result, rising Treasury yields are causing discounted cash flow models to devalue forward earnings while earnings are falling because of higher input costs and sagging demand. That’s not a winning recipe for stocks.
Yet stocks don’t rise or fall in a straight line, and October’s track record may offer comfort if you’re feeling down about your account balance because of returns in September.
How stocks perform in October
According to the Stock Trader’s Almanac –- an excellent resource for historical probabilities – September is the worst month for stocks. However, October is better, particularly in mid-term election years, the worst performing year in the Presidential Election cycle (the Pre-election year is the best year for returns).
Since 1950, October has been the 7th worst month for returns. However, returns are substantially better than usual in mid-term election years, with the S&P 500 and NASDAQ returning 2.7% and 3.1% on average. Between 1999 and 2003, Octobers were big winners during the Internet bust when high-valuation stocks were similarly entrenched in a vicious bear market. The Stock Trader's Almanac writes that October "turned the tide in 12 post-WWII bear markets: 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001, 2002, and 2011."
October also ends the Almanac’s “worst six months of the year,” setting the stage for historically stronger returns. According to the Almanac, November is NASDAQ’s best month of the year during mid-term election years, returning 3.5% since 1971. Furthermore, the six months from November through April have generated an average return of 7.5% on the Dow Jones Industrial Average, versus a 0.8% average gain from May through October.
Since many bear markets have coincidentally ended in October, it’s called a “bear killer.” Nobody knows if October will lay the groundwork for gains again this year. Still, to paraphrase Twain, history often rhymes, so it’s certainly worth seeing if buyers materialize next month.
Don’t overplay hands
Of course, probabilities aren’t certainties. If they were, everybody would be rich. There are always exceptions. For instance, during the Great Recession, buying in October 2008 subjected investors to another big wave lower to the March 2009 bottom. For this reason, you don’t want to throw caution to the wind just because of historical precedent.
In “A Time for Patience and Very Short-Term Trading,” Real Money’s James DePorre reminds us that surviving bear markets requires prudence. He writes:
“The most important thing to do at this point is to embrace the fact that we are in the jaws of an ugly bear market. Recognize that reality and don't fight it. There is endless speculation from pundits in the business media about how much longer this bear market will last. No one knows, and everyone is just guessing. The best course of action is to stay patient and let the market action tell you when things are improving. It will be very obvious, and you do not need to be fully invested at the exact low to profit. [emphasis mine]”
Many investors make the mistake of going “all-in” during a bear market in hopes of winning back their losses when they should be embracing progressive exposure, like famous trader Mark Minervini.
Minervini's progressive exposure concept suggests investors should dip their toes to test the water before jumping in. If those small tests pan out, slowly increase exposure as conviction and confidence build, protecting your downside by using stop losses. If those first small trades don’t work, then stops will keep losses small, allowing you to regroup and try again the next time you feel there’s an opportunity.
A patient approach is why Jeffrey Hirsch, the person behind the Stock Trader’s Almanac, overlays moving average convergence/divergence, or MACD, to determine the appropriate entry to profit from the historical November through April strength, rather than just jumping in blindly.
As a reminder, The Moving Average Convergence/Divergence (MACD) subtracts the 26-day Exponential Moving Average (EMA) from the 12-day EMA. A bullish or bearish signal triggers when that result crosses over or below zero, or the 9-day EMA.
Back to DePorre:
“If you are going to trade this market, the most important issue is your time frame. There will be counter-trend moves that are tradable but trade them and don't let a failed trade turn into a long-term investment…I'm quite sure there will be some bottom fishers anxious to catch a bounce into a big gap-down open this morning. If you are playing, just make sure you manage the trade very tightly and are ready to exit quickly if it doesn't work [emphasis mine]…If you are a long-term investor, this is the time for patience. There is no reason to rush to put precious capital to work right now.”
The Smart Play
Bear market rallies vary in size and length, so don’t assume any low is also “the” low. It's still important to play defense until there’s evidence that stocks have found their footing.
Maintaining a larger than normal cash position, opportunistically shorting stocks or the index, focusing on recessionary-stage baskets and lower-beta dividend-paying stocks, and avoiding margin to sidestep margin calls remain helpful ways to minimize losses in a bear market.
If your time horizon is long enough, dollar-cost averaging into the S&P 500 index during a bear market remains a historically powerful way to profit from the next bull market, whenever it may come. If you’re a trader or intermediate-term investor, stocks are approaching oversold heading into October, which has historically been an intriguing month, especially in mid-term election years. However, stocks can remain oversold for long periods, so keep a close eye on the market to see if it can turn up and only then position accordingly. There’s no need to rush. Instead, be patient and employ progressive exposure when the time is right.