Is Another October Surprise in the Works?

I have been asked countless times in the past month why it is that share markets seem to have a difficult time navigating the autumn months. Obviously, there is a healthy amount of fear regarding the next 29 days, as the memories of last year are still firmly intact. Yesterday’s 203-point drop in the Dow Jones Industrials Average has done nothing more than rekindle those sour memories. While the question ‘Why October?’ is largely rhetorical in nature, we can certainly take a look at history for some potential causes for the blowups.

Not helping our prospects for avoiding another October surprise is the fact that almost nothing has been done to rectify the underlying problems facing the U.S. economy. Plenty has been spent to bailout various enterprises, but until a healthy, unsubsidized demand for goods and services exists at the consumer level, we will continue to spin our wheels. A fantastic example is the cash for clunkers program. The massive infusion of subsidies did manage to increase auto sales, but now that the program has ended, we’re heading right back to where we were before. This is evidenced by Ford’s U.S. auto sales immediately dropping 5.1% after the program was terminated.

The Panic of 1819

The panic of 1819 was the first stoic example of the boom-bust cycle in the nascent United States. Oddly enough, this panic, and the crisis in which we are currently embroiled, have striking similarities even though they occurred nearly 200 years apart. For starters, the panic of 1819 was a direct result of internal factors rather than external ones. Occasionally, a crisis in a nation can happen because of someone else’s doing. This one was mainly due to the rampant spread of private bank notes of varying quality and value thanks to runaway inflation caused by borrowing for the War of 1812. Oddly enough, the panic of 1819 resulted in many of the same things we are seeing today: foreclosures, unemployment, bank failures and significant slowdowns in both agriculture and manufacturing activity. This crisis is important because it is the country’s first example of a homegrown crisis and really determined the anatomy of many subsequent events. Essentially what happened was a boom of sorts, which resulted in malinvestment, financial and economic dislocations, and the decay of underlying fundamentals followed by a severe correction of the imbalances to restore economic and financial order.

However, there was another interesting twist in many of these early panics, and it had to do with our money itself. One of the characteristics of early banks in the U.S. was to offer paper bills that were redeemable for specie (metallic) money. Redeemability was a huge factor in the confidence in the paper bills.

Unfortunately, analogous to today’s Fed, these early banks had the propensity to print and circulate bills far in excess of the amount of specie they had on deposit, making them susceptible to bank runs. Many of the early panics in the new United States were caused because banks got greedy and overstepped their boundaries. Sound familiar? The more things change, the more they stay the same.

Unfortunately, when these bank runs occurred, the banks would merely run to the government who made the rather foolish decision to suspend specie payments on bank notes, effectively ripping off the holders of the bank notes. Incidentally, as a result of the panic of 1819, unemployment in Philadelphia, for example, reached near 90% and almost 2000 workers were put into debtors prisons. In addition, displaced and unemployed workers lived in tents outside the city. I am sure this irony is not lost on anyone who has seen some of the tent cities around America as a result of runaway foreclosures.

The important point underlying many of the panics of the 19th century was the fact that they were rooted in the monetary system and/or the economy in general. This paradigm shifted with the advent of share markets and the panics oftentimes transitioned from monetary and economic panics to stock market crashes and then to a hybrid situation from 1929 through the start of World War II.

The Crash of 1929 – October 24-29, 1929

I am not going to rewrite the chronology and factors surrounding the Great Depression. For anyone who is interested, there is an article here from last fall. This crash was the first well-defined example of a stock market crash and a significant economic contraction happening simultaneously.

Not surprisingly, this is where the history books usually get it wrong. They oftentimes assert that the market crash caused the Great Depression. Nothing could be further from the truth. The economic boom of the roaring 1920’s had run its course leaving (as in prior examples) financial and economic dislocations, overleveraged consumers and a general feeling the boom would last forever. The mountain started shaking in the summer of 1929 and by autumn panic gripped the markets, resulting in a 2-day, 23% sell-off in the DJIA. By the middle of November 1929, the DJIA had lost 40% of its value.

What happened next is crucial to understanding what is happening right now. The market then made a valiant attempt to rally, bringing back many investors from the sidelines as the Dow mounted a furious charge into 1930. However, the rally didn’t stick, conditions worsened and by the time 1932 rolled around the venerable index had lost 89% of its value. It would take 25 years for the Dow to recover that lost value in nominal terms.

If you think this cannot happen again, then you are incredibly naïve.

The Crash of 1987 – October 14th - 19th, 1987

In financial folklore, the crash of 1987 is one of those events that cannot generally be explained since there were no obvious dislocations. P/E ratios were high, but not extreme, investors were not grossly overleveraged and the economy was comparatively healthy. There have been many theories about financial raiders cashing in on the sudden decline, and given what we’ve seen recently the idea of someone triggering a crash for their own benefit doesn’t seem too far out of the realm of possibility. The interesting thing about the 1987 event was the recovery time. On a percentage basis, the loss was massive – 31% in five days for the DJIA. Yet it took just a tad under two years for the index to fully recover in nominal terms.

What was rather poignant about the ’87 crash was the response. This was the event that gave rise to the shadowy President’s Group on Working Markets, often lovingly referred to as the Plunge Protection Team. In addition, various circuit breakers were placed in the markets to halt trading if certain conditions were met.

After the invocation of trading curbs and the President’s Working Group, investors seemed to be lulled into a sense that the markets could never again drop significantly. That has certainly not been the case, and in case anyone is counting, the events are becoming larger and closer together. In 1997 and 1998 we had the Asian crisis and the Russian default, followed by Long Term Capital Management. The new century was ushered in by a vicious bear market thanks largely to overvalued Internet stocks. That bear market ended in 2003 and was followed by a steep nominal recovery in share prices only to see markets fall apart once again after the late 2007 top.

In summation, given everything we know about the underlying economic fundamentals and the nature of bear market rallies, it certainly won’t be much of a surprise if we have another horrendous October. And if the first day is any indication, it could be a long month.

Comments

[Gary A:]

Nice article. It is way past time for a creditor prison. I would like to see Greenspan, Bernanke, Paulson, Geithner, Dodd, Dimon, Frank, Rubin, and the entire BIS in that prison.

But alas, in this life justice will not happen for the banksters.

Oct 02 10:24 PM

[Roger Knights:]

"It is way past time for a creditor prison."

Too big to jail.

Oct 02 10:32 PM

[sethmcs:]

I really wish the author could give more theories as to why market corrections tend to occur in October.

Oct 03 12:07 AM

[AlphaKing:]

Here we are now 3% lower than where I gave a warning signal up at 9850. As suggested in my initial warning comment I believe we still have at least another 1-2% move lower in the short-term, and then there is some strong support. If we get a break below 9300-9350 level it should confirm an even stronger move lower, which is moderately likely due to the bearish pattern formation with which a solid break below 9300 would confirm. Confirmation of a trend line break should then bring at least another 5% drop, but I believe closer to 12-15% fall technically from there in the medium term.

Oct 03 12:41 AM

[AlphaKing:]

Market corrections in Fall months are just part of the cyclical nature of the markets. Similiar to the longer-term cyclicality of the markets tending to have corrections during the beginning or end of a decade. There really is not one reason for why the downcycle tends to be around this time, but a multitude of them.

Oct 03 12:47 AM

[Kimball Corson:]

Why are the autumn months more difficult for the market? I think that as the weather turns colder, leaves on trees die, grass goes brown, we get less sun, and as we head toward winter people are affected and become less optimistic. Many people in the pacific northwest, for example, have tanning lamps or tables to give themselves more "sun" exposure as a means of combating depression in that often dreary and overcast part of the country. Keynesian "animal spirits" wane and we tend to look inward more. All of this is not good for a buoyant market.

Oct 03 01:43 AM

[E Nuff Sed:]

Enjoyable article. I would guess based on seasonality buy in November and sell in May would make sense. Though being out of the market this Summer would have been a big mistake.
I am sure some technician somewhere has trading rules around that.

Oct 03 02:45 AM

[Moon Kil Woong:]

SethMCS: Basically September, October, November is bad for a few reasons I can think of.

1) Summer seasonality especially in the housing market is over (people usualy buy houses during summer break). 2) People worry about the holiday season ramp. 3) Companies liquidate investments to get money to stock up inventory for the holidays. 4) And some say October crases are somewhat in response to fear of November selloffs. Thus maybe September falloffs are people trying to get a headstart on October declines. The last explaination is one of the weaker arguments yet is persistently mentioned as the primary reason by "financial news" coverage such as CNBC.

Oct 03 02:59 AM

[Panus Skept...:]

"...almost nothing has been done to rectify the underlying problems facing the U.S. economy."

Yeah, well, as long as the financial lobbyists paralyze the Senate, little can be expected there. OTOH, Obama's executive branch did a pretty good job keeping us from falling into a catastrophic Great Depression, but it's bad form around here to say "thank you."

Oct 03 03:14 AM

[jeandit75:]

"it certainly won’t be much of a surprise if we have another horrendous October. And if the first day is any indication, it could be a long month"

I'd say about 31 days

Oct 03 04:35 AM

[Vuke:]

If Bernanke and the Plunge Protection Team have their way there will be no great October surprise, particularly as everyone is warning of one. Should it occur most astute investors now hold a position in gold stocks the price of which, as if by magic, will rise, balancing losses.

Gold, recall, is central bankers "currency of last resort". A rise in the price of gold is an effortless way to inject a lot of new money into the system.

Oct 03 09:40 AM

[Albertarocks:]

On Oct 03 02:59 AM Moon Kil Woong wrote:

> 1) Summer seasonality especially in the housing market is over (people
> usualy buy houses during summer break).

I'm very reticent to correct one of my favorite writers but as a former real estate analyst (amateur) I'd like to fine tune this concept a little bit without ruining your reasoning. The seasonality of the residential real estate sector is stunning in its regularity (normally). The summer months themselves are the deadest time for residential real estate sales throughout the USA and Canada... every single year. There are many reasons as to why sales kick off so strongly in April but to sum it up quickly... it has mostly to do with parents reluctance to disrupt their children's school year, so they buy in spring and then make the actual relocation in the summer.

Then there is almost always a strong resurgence in real estate sales starting in October and lasting through to Christmas... then deadsville once again until the spring. I'm wondering if the regular flow of capital into real estate every October (during regular times when the world isn't on the brink) would result in a drawdown of funds from the stock markets? I'm not suggesting that to be fact... just proposing a possibility.

>The last explaination is one of the weaker arguments yet is persistently mentioned as the primary reason by "financial news" coverage such as CNBC.<

I think your last explanation is actually one of the stronger arguments... the main stream median itself, being nothing more than an arm of the power brokers and a puppet that dances to the tug of the strings made of dollars. IOW, I think the idea of October crashes is blown totally out of proportion by the MSM for the benefit of their masters and rulers. The fact is that Octobers are no worse than any other month, except for the fact that 3 notable crashes have started in Oct. Indeed, Oct. is often a springboard into the "best 6 months of the year" trading strategy.

As we all know, the markets have fallen for the past two weeks (the last two of those days being in October). It's still possible this is only a correction, but if it doesn't turn around almost immediately, it could certainly be one of those nasty Octobers to be remembered. Having said that, and with what could be a two week correction behind us, and with the incredible number of stick saves we've seen out of the banksters all the way through the rally off the March lows... this could also end up being a barn burner of a good month for the markets.

In my personal view... this market is so overbought it's a case of irrationality on steroids. The internals are breaking down and the mood isn't good. I'm of the opinion that the "dumb money" retail investor isn't even in this market yet... and he's not coming back until he sees a meaningful correction. I don't think the "dumb money" is anywhere near as dumb as Wall Street and its pump jockeys think.

I realize probably everybody who participates here on SA are in the markets in one form or another... I don't consider any of you as the "dumb money".

Oct 03 10:33 AM

[Mad Hedge F...:]

xse For the last six months there has been a great big whopping contradiction in the markets. The stock market has been discounting a return to the “Roaring Twenties,” while the bond market has been anticipating the return of the “Great Depression.” After yesterday’s publication of the Labor Dept.’s September nonfarm payroll number showing the loss of another 263,000 jobs, it looks like the bond market now has the upper hand. The really disturbing aspect of this number is that 57,000 teachers were fired, as states chop budgets to the bone. This is really eating our seed corn by the handfull. Stocks have dropped 5% from last week’s peak, as the bond market soared, the ten year yield reaching nosebleed territory of 3.05%. My call to buy the TBT, a leveraged bet that US Treasury bonds would fall, is starting to look a little green about the gills. The dollar still maintains its flight to safety status, which to me, is one of the great ironies of all time. It’s like that reprobate, alcoholic uncle with the bad teeth, who, when your car breaks down in the middle of a downpour in a bad neighborhood, will always let you crash on his sofa. Let’s call him your Uncle Sam. You have to hand it to PIMCO’s inveterate card counter, Bill Gross, who says this is all about transitioning to a “new” normal of 1%-2% real GDP growth. That’s why he was loading the boat with bond yields at 4%, a ballsey move at the time, which now smells like roses. I guess that’s why they call him the “Bond King.” As for me, I’m never wrong, just early. Sometimes way early.

Oct 03 12:45 PM

[Tomcat101:]

We will trend down through October 9th, then rally through the end of the year with a dip here or there.

It'll be early next year before people wake up and realize that "Change You Can Believe In" means high taxes, high gas, high unemployment, high utility bills, high inflation, a screwed up health care system, riots, just enough money to get essentials at Wal-Mart or Family Dollar, and so on.

2010 will be a bad year. Count on it. That's change you can believe in.

Oct 03 01:46 PM

[Zell:]

Should it be called a "Surprise"? I've been reading Christopher Story for the last 5 years, and in the last 3 years he has been warning of the greatest global financial collapse ever! He doesn't use charts, trends, P/E ratios, or any of the 1000's of scientific future talk models. He just follows the Criminals. He's been at it for 40 years.

Oct 03 02:15 PM

[DavyJ:]

Re: "The interesting thing about the 1987 event was the recovery time. On a percentage basis, the loss was massive – 31% in five days for the DJIA. Yet it took just a tad under two years for the index to fully recover in nominal terms."

Another interesting thing about 1987 is that it was an up year. The DJIA finished 1986 at 1896.00 and finished 1987 at 1938.80 a 2.26% increase. Same for the S&P 500.

Oct 03 02:42 PM

[logicalman:]

^^and if the first day is any indicator, it could be a long month...i agree it could be a month to go LONG!!!

Oct 03 07:48 PM

[logicalman:]

would you be the jeandit75 who predicted S&P would be below 400 before end of summer??? end of summer S&P close 1065..so much for your predictive abilities..but if you predict often, some day you could be right..your uncanny prediction came about on April first....at the time i thought it was an April Fool joke..but i think you were serious!!!


On Oct 03 04:35 AM jeandit75 wrote:

> "it certainly won’t be much of a surprise if we have another horrendous
> October. And if the first day is any indication, it could be a long
> month"
>
> I'd say about 31 days

Oct 03 08:10 PM

[logicalman:]

oh boy, there might be a few!!!


On Oct 03 10:33 AM Albertarocks wrote:

> On Oct 03 02:59 AM Moon Kil Woong wrote:

Oct 03 08:16 PM

[Chuckols:]

Kimball-What you refer to seems to me to be the realization that social mood is the driver for activities that are manifest in most everything we recognize as organized human behavior. Financial markets are the easiest activity to measure by many metrics but fashion, music, faith, auto design and on and on are consequential results of the impact of social mood on society at large. I am learning that socionomics is a powerful counter intuitive way to look at the world around us. I don't propose to understand it very well, only that is seems to fit what I have lived and what I now see. It sure does explain a lot that to me was never expalable before to my satisfaction. Google The Socionomic Institute for a better understanding beyond my capacity to express.


To add another comment, then I am "off the stump", as soon as market sentiment turns the market turrns. One precedes the other. Is not that an interesting example of measureable relationship that many have grabbed onto and it is interpreted in an intuitive sense viz., the market declined and therefor sentiment has fallen as a result. NO, it is the other way around but who would agree ! It is too "counter intuitive" to imagine. To do so would tag one as "some kinda nut case!". So be it.

Kind Regards,Chuckols
On Oct 03 01:43 AM Kimball Corson wrote:

> Why are the autumn months more difficult for the market? I think
> that as the weather turns colder, leaves on trees die, grass goes
> brown, we get less sun, and as we head toward winter people are affected
> and become less optimistic. Many people in the pacific northwest,
> for example, have tanning lamps or tables to give themselves more
> "sun" exposure as a means of combating depression in that often dreary
> and overcast part of the country. Keynesian "animal spirits" wane
> and we tend to look inward more. All of this is not good for a buoyant
> market.

Oct 03 10:39 PM

[Kevin Walmsley:]

October tends to be a violent month--going back centuries--because it's harvest time. Crops are brought to market, resulting in wildly fluctuating commodities prices. Loans are paid off, monies reinvested, and huge sums of money change hands. What's more, the entire agrarian economy would shut down pending Spring.

Oct 04 01:25 AM

[aussiereader4:]

October, because most business is seasonal. If the summer is poor, it gets reported in October. August is looking poor.

Oct 04 01:59 AM

[ebworthen:]

Beginning of the quarter, kids back in school, weather getting colder, holiday travel and purchases will determine bottom line for many companies. If you need money to buy presents and travel, it's a good time to get your chips off the table (take profits).

People also make decisions (resolutions) on New Year's Day. Fund managers would like statements and balances to show good things at this psychological benchmark. Besides, with the holidays much decision making and activity slows and is left for the New Year. In other words, October is a good time to sell and hunker down for the Winter.


On Oct 03 12:07 AM sethmcs wrote:

> I really wish the author could give more theories as to why market
> corrections tend to occur in October.

Oct 04 04:18 PM

[Jonathan Ch...:]

There are many factors as to why the market plunges in October. One not mentioned in these remarks is the fact that many funds and partnerships close their books for the year between the middle of October and the end of the calendar year. This means they take their profits, declare their losers, declare distributions and begin to build their portfolios for the next year. At the same time, people are selling stock to take loses and profits. The net of this is downward price pressure for much of the month of October, and improving fundamentals in November, before people start to take vacations and celebrate the holidays.

This is not a "Proof"s to why prices decline in October, but it is one factor.

Oct 04 08:33 PM

[E Nuff Sed:]

Looks like the real surprise would be a positive surprise given so many people are expecting a correction. However this would only delay the inevitable to November.

Oct 04 10:31 PM

[enigmaman:]

Good article with information that is spot on though that doesnt mean anything bad or good will happen unless the perception of what America believes shifts dramatically as it appears to be doing. Markets are based on emotions, Greed and Fear, we saw greed in 1999 as well in 2007-08 we also saw fear in 1999 and 2008-09 the difference this time is dramatic. During past recessions, from 1970s on we came out of each pretty much unscathed, a bump in the road so to speak, but as we invested more and relied on our own ability to secure our retirement we took more risks and suffered more losses, causing stress and anxiety about the future. With the dot com crash we were like deer caught in the headlights, it caused serious damage to savings (50% losses +) and peace of mind but we shook it off because the crash was considered an anomaly, we saw our investments climb back over the next seven years by 50% but many moved heavily into real estate investments which did great, so we felt OK, then we saw the bottom fall out of real estate in 08 and in the next 6 months the market declines also took our savings (50%+), and then our jobs as well as our feeling of well being and this is what makes this recession worse then all others in recent history. The combination 1-2 punch this recession delivered knocked us on our butts, dazed and confused, when we got up and looked around all we could see is devastation that personally affected every single one of us, and we knew it was different this time. So to think we will go back to business as usual, that human nature dictates this is naive because the damage that this recession has and will inflict will last for many years just like after the GD. Mark Twain once said " If a cat sits on a hot stove it wont sit on another hot stove again but it wont sit on a cold stove either because its over learned from its bad experience" the same can be said about most people today, they have over learned from their bad experiences the last ten years. If Oct proves to be a bad month I would expect it to get worse because nobody and I mean nobody wants to lose what they were able to make back in the past six months. This recession has and will fundamentally change the way investors view the market, ten years of 0 gains has only happened one other time, yep during the GD, so its not about reality its all about perception and on main street the perception is not very good

Oct 05 08:46 AM

[AlphaKing:]

I am still standing by this scenario developing and a much larger market correction lower if the support levels do not hold, although the support levels have of course moved up.

The support levels below that were mentioned as 9300-9350 are now at 9650 level. A solid break below that level should bring the markets close to 6-8% lower. Today it seems as if they are trying to test those suppor levels. For all trend followers now may be a good time to enter long, or add to your position.


On Oct 03 12:41 AM AlphaKing wrote:

> Here we are now 3% lower than where I gave a warning signal up at
> 9850. As suggested in my initial warning comment I believe we still
> have at least another 1-2% move lower in the short-term, and then
> there is some strong support. If we get a break below 9300-9350 level
> it should confirm an even stronger move lower, which is moderately
> likely due to the bearish pattern formation with which a solid break
> below 9300 would confirm. Confirmation of a trend line break should
> then bring at least another 5% drop, but I believe closer to 12-15%
> fall technically from there in the medium term.

Oct 30 01:56 PM