In late September, I talked about the “October effect”. And this October lived up to the hype.
The month of October has seen some of the biggest stock market crashes of all time – in 1907, 1929 and 1987 for U.S. markets, and the Octobers in 1997 and 2008 were particularly punishing for Asian markets.
Stock market performance this October was almost as bad. The good thing is, history suggests that what’s next won’t be so scary.
A tough year
Markets have been building up towards a disappointment. Until very recently, the U.S. bull market hadn’t slowed down. The U.S.-China trade war has been all over the headlines. Rising interest rates have been a drag. Markets from Italy to Turkey and around the world have been hit by shocks and corrections.
In October, the S&P 500 fell 6.8 percent. That’s its fourth-worst performance in October since 1978. And it’s around 8 percentage points below the average returns for the month during 1940 to 2017.
The S&P 500 has posted lower returns only in October in 1978, 1987 and 2008, when it fell 8.7, 21.5 and 16.8 percent, respectively. Over the last 41 years – despite October’s reputation – market returns have been negative in October just 38 percent of the time. The average return for the month, excluding October 2018, was 1.1 percent.
How about Asia?
October was particularly bad for Asian markets.
The MSCI Asia ex Japan Index was down 10.8 percent. That’s the third-worst October since the 1997 Asian financial crisis (when the index was down 22.3 percent) and the global economic crisis in 2008 (when it dropped 24.1 percent).
Historically, around half of Octobers in the past saw a negative return in the MSCI Asia ex Japan index.
When it does, you know you’re looking at a potential winner that could rocket as high as Bitcoin’s historic 7,247%.
So what happens next?
The table below shows the returns for the S&P 500 after its worst Octobers over the past 40 years. All three times, the market was up by double digits a year later.
And three and five years later, a bad October was nothing but a distant memory.
As we enter what’s historically the best time of the year for stocks, history suggests that the chances are good that the S&P 500 will once again recover from its October fall.
But history isn’t as kind for Asia.
The table below shows the returns for the MSCI Asia ex Japan after its worst Octobers. The Asian financial crisis in 1997-1998 was a long-term drag on performance (and a bad October in 1997 was one chapter of that). Asian markets recovered much more quickly from the 2008-2009 global economic crisis, though.
So what does all this mean?
History suggests that the S&P 500 won’t be derailed after a bad October. That said, only three readings isn’t a big sample size. And as we’ve said before, U.S. markets are at historic highs. And at some point, mean reversion will kick in for U.S. markets.
By comparison, markets in Asia offer much lower valuations. The on-going trade war is hurting investor sentiment and may do a lot more damage if it continues.
So as we head into the end of the year, make sure your portfolio is sufficiently diversified – with both Asian and U.S. stocks.
Publisher, Stansberry Churchouse Research