2012-11-05 08:03:02
October 27 2009| Filed Under Currencies, Economics, Economy, Financial
Crisis, Financial Theory, Forex, Forex-Beginner, Recession
October is a unique month. In the west, October is a transitional month, autumn
sliding 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 has a special place in finance, known as the
October effect, and is one of the most feared months in the financial calendar.
In this article we'll look at whether there's any merit behind this fear.
The events that have given October a bad name span 80 years. They are:
The Panic of 1907 (October 1907)
A financial panic threatened to engulf Wall Street, mostly owing to threats of
legislative action against trusts and shrinking credit. 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 Fed before the Fed existed.
Black Tuesday, Thursday and Monday (October 1929)
The Crash of 1929 was bloodletting on an unprecedented scale because so many
more people were involved in the market. It left several "black" days in the
history books, each with their own record breaking slides. (For more, see The
Crash Of 1929 Could It Happen Again?)
Black Monday (October 1987)
Nothing says Monday like a financial meltdown. In 1987, automatic stop-loss
orders and financial contagion gave the market a thorough throttling as a
domino effect echoed across the world. The Fed and other central banks
intervened and the Dow recovered from the 22% drop quite rapidly. (See What Is
Black Monday? for more.)
Taking the Blame for September
Oddly enough, September, not October, has more historical down markets. More
importantly, the catalysts that set off both the 1929 crash and the 1907 panic
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 trusts, 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.
September has its share of "Black Days," too:
Black Friday
The original "Black Day," Black Friday (1869), was in September. 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 $5 million in gold, dropping the price of gold by $25 in a single day
and ruining many speculators.
Black Wednesday
Black Wednesday, Soros' raid on the British pound, is another September event
considered infamous by people outside of the forex community (within the forex
community, it's revered as of one of the greatest trades ever made). Soros made
a billion on the deal, but the British government lost billions trying to shore
up their currency leading up to the eventual capitulation. (To learn more, see
How Did George Soros "Break The Bank Of England"?)
Black Swans
September 2001 and 2008 single day point declines in the Dow were bigger than
Black Monday 1987, the former owing to the attacks on the World Trade Center
and the latter to the subprime mortgage meltdown. The 2008 September plunge
went far beyond the U.S. economy, trimming almost $2 trillion from the global
economy in a day. (For more, see our Investopedia Special Feature: Subprime
Mortgages.)
Taken as a whole, a very strong argument can be made for September being worse
for the markets than October.
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. 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. (Read more in, Pick Stocks Like Peter Lynch.)
Conclusion: October Effect Unjustified
October gets a bad rap in finance, primarily because so many black days fall in
this month. This 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 Lehman's collapse, more stocks fall in November and December
due to year-end rebalancing, and many 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 crashes restrict themselves
to one particular month, October is no more prone to bad times than the other
11 months in the calendar. (For more, see our Market Crashes Tutorial.)
by Andrew Beattie
Andrew Beattie has spent most of his career writing, editing and managing Web
content in all its many forms. He is especially interested in the future of
search and the application of analytics to the business world. In addition to
being a long-time contributor to Investopedia.com, Andrew has been working on
ForexDictionary.com.