The numbers show crashes are no more likely in October than in any other month You may be able to profit from investors’ irrational belief that crashes are especially likely to occur in October. Their belief leads the stock market to be artificially depressed during October, which in turn means that investments made at the month’s low will quite likely show a profit by the end of the year. In 93% of the years since the S&P 500 was created in 1957, for example, it was higher at year’s end than at its October low.
Its average gain over this two-plus-month period was 7.4%, nearly double the comparable average gain of the other 11 months. Investor sentiment is a major source of this pattern. Consider the average recommended equity-exposure level among a subset of several dozen stock-market timers who focus on the Nasdaq market.
This segment of the stock market is particularly sensitive to changes in retail investors’ mood. Since 2000, as you can see from the above chart, October’s average equity exposure to this segment of the market has been just over half that of the other 11 months — 13.6% versus 26.1%. The market’s bounce from its October low is therefore a classic illustration of contrarian analysis.
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Two studies confirm that sentiment, rather than anything fundamental, is the source of investors’ low equity exposure in October. One traces to research led by Xavier Gabaix, a professor of economics and finance at Harvard University. According to a complex model developed by him and his co-authors, there is just a 0.06% probability that, at any time in October, there is a one-day crash as deep as 1987’s (a drop of 22.6% by the Dow Jones Industrial Average ).
The probability of a crash as severe as 1929’s (12.8%) is only marginally greater, according to their model, at 0.30%. Furthermore, Gabaix told me in an email, these miniscule probabilities apply to any month; there is nothing special about October. The fact that the two worst crashes in stock-market history occurred in October is almost certainly nothing more than a coincidence.
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