Even before the Dow Jones Industrial Average dropped 6 percent last week, market watchers were anticipating a dip in the market–the so-called “October curse.” Does the stock market really perform worse during October? And, if so, why?
Anecdotal evidence supports the October curse. The 1929 crash happened in October, as did the 8 percent one-day drop in 1937, 1987’s Black Monday, and the big correction in 1997. In all, five of the 10 largest one-day drops in Dow Jones history have happened in October.
But statistical analysis reveals a murkier picture. Since 1928, when the DJIA began measuring the performance of 30 leading stocks, October has produced average monthly returns (calculated by dividing each year’s Oct. 31 Dow level by its Sep. 30 level) of -0.21 percent. While negative, these returns are not the year’s worst; May and September yield returns of -0.39 percent and -1.19 percent, respectively. And since 1990, October has ranked seventh out of the 12 months, with an average return of +0.36 percent. Other indices are similarly mixed: October has historically been the worst month for the Nasdaq Composite Index, but ranks seventh for the Standard & Poor’s 500.
While October has historically been a below-average month for the stock market, the “curse” is an exaggeration. Often, there are no major drops during October. And in 1982 and 1998, the DJIA increased about 10 percent for the month.
When the Dow drops in October, Wall Street points to three major factors. First, many companies report their financial year-end earnings in October. If a company underperforms expectations early in the year, the market is more forgiving, since there is still time for the company to recover before year’s end. In the third and fourth quarters, though, poor earnings reports often cause a company’s stock to fall (this helps explain Thursday’s drop in the IBM stock price after the company’s earnings announcement). Of course, the market also reacts more strongly to companies beating expectations, so this may simply explain October volatility (and the frequency of big drops), rather than the overall downward trend.
Second, many mutual funds close their books at the end of October. In order to ensure that annual fund performance appears strong, managers may engage in “profit taking,” or selling stocks that have increased in value. As with any product, the increased number of sellers tends to drive down prices. Third, some analysts speculate that basic psychology plays a role in October declines. While the year’s first few months are a time of optimism, they say, the end of the year is characterized by pessimism compounded by the onset of winter. People may therefore be less likely to make risky investments. (In November and December, this effect could be counteracted by holiday bonuses and efforts to make investments before the end of the tax year.) And past crashes may make October downturns more likely: Since they have left a psychological scar, investors may be especially skittish during the month.
If the October stock slump were regular and predictable, investors’ rational reactions would tend to counteract it. That is, if an investor knew that stock prices would fall each October, he or she would view the month as an opportunity to buy into the market at lower prices. As investors looked to enter the market in October, they would push stock prices up. Evidence of the October slump is not strong enough for most investors to make decisions based on this expectation. But this year, some analysts did advise their clients to look for good deals in October. And when the stock market recovered ground this Monday, many observers attributed the gain to bargain-hunting investors.
Explainer thanks MSN MoneyCentral and markethistory.com.
