As the calendar flips to October, stock investors with long memories start to get nervous. After all, October is home to some of the most notorious stock market crashes in history.
Any whiff of strong selling will ignite jittery memories of a long list of October market panics including: the Wall Street crash in 1929, Black Monday in 1987, Friday 13th mini-crash in 1989, the October 1997 sell-off triggered by the Asian economic crisis and, more recently, the 2008 financial crisis.
“Seven of the 20 worst losses in the Dow’s memory happened between Oct. 15 and Oct. 29, including the 1929 and 1987 crashes,” says Hilary Kramer, editor of the New York City-based GameChangers stock newsletter.
Investors can take heart, just because the ghosts of October past may be lurking on Wall Street doesn’t necessarily mean investors will be spooked into selling. But, it doesn’t hurt to be prepared.
Why October? There are a lot of theories about cash flows and quarterly window dressing, Kramer says.
[See: 10 Long-Term Investing Strategies That Work.]
“The most compelling explanations revolve around the calendar itself. When October rolls around, investors have to start paying attention. There’s less room for hypotheticals,” Kramer says. “This is the last chance investors have to adjust ahead of an election, late-year Fed meetings or the simple fact that the performance clock runs out on Dec. 31.”
Is the 2016 stock market vulnerable to a correction, crash or even a bear market? Some say yes to a correction, which is typically defined as a decline of at least 10 percent.
“I believe the market is vulnerable to a correction at this point because of valuation and an inflection point in central bank policy,” says Chris Zaccarelli, chief investment officer at Cornerstone Financial Partners in Huntersville, North Carolina.
Also, the current bull cycle in stocks is old by historical measures. The current bull market expansion is both longer in duration — seven-plus years — and larger in magnitude than the average expansion, says William T. Northey, chief investment officer of the private client group at U.S. Bank in Great Falls, Montana.
“Expansions rarely die of old age, but rather from the onset of a recession or other external shock,” Northey says. “We don’t see the former as a high probability event in the next 18 months, while the latter is difficult to predict.”
There are a variety of shocks that could trigger a correction in stocks. Here are three risks analysts are watching:
Banking system. Financial sector trading turned jittery last week amid reports of big investors pulling funds from Deutsche Bank (ticker: DB) with concerns about a U.S. Justice Department probe into its mortgage-securities activities.
“If it truly looks like Deutsche Bank has turned into a systemic risk factor, we could see the S&P 500 shudder back to the February low before recovering,” Kramer says.
Presidential election jitters. Despite a recent narrowing of the polls, Wall Street analysts generally say the stock market is expecting Democratic contender Hillary Clinton to win the White House.
“The U.S. election is another example of a known event which may lull investors into a false sense of security that the outcome can be predicted with certainty in advance,” Zaccarelli says. “If the markets continue to trade according to conventional wisdom and we get an unexpected result, that could cause a selloff.”
Unexpected geopolitical or economic risk. “It’s always easier to identify a vulnerable period in the market than it is to name a specific catalyst that will trigger the next correction,” Zaccarelli says.
There are many lessons that investors can learn from October’s notorious past.
[See: 13 Ways to Take Emotions Out of Investing.]
“Every October sell-off has gone down in history as a buying opportunity,” Kramer says. “All the capital destroyed on Black Monday was restored by July 1989, so those who had the cash and the conviction to buy in and ride the aftershocks were in the money within months.”
Zaccarelli agrees. “The lessons from history are clear,” he says. “When markets are down you are buying on sale, so instead of fearing a drop in prices, use that opportunity to purchase those investments, including stocks and ETFs at a good price.”
You may not be able to control the markets, but you can control your emotions, reactions and actions to take advantage of a dip. When sentiment overcomes the intrinsic value of securities, the market can see wide and seemingly irrational swings in pricing, Kramer says.
“When it overreacts to the downside, great stocks become available at deeply discounted prices because few buyers are willing to step up — fear is in control,” she says. “As they say, other traders’ fear is your friend, provided you have the willpower and dry powder to exploit it.”
Most people are hard-wired to do the wrong thing, either buying when markets are high or selling when they are low, Zaccarelli says.
“Most of the greatest investors of all time use some variation of the phrase: Be fearful when others are greedy, but be greedy when others are fearful,” he says.
There’s usually a trigger in any sudden Wall Street decline, so when you’re hunting bargains, steer clear of stocks that are directly exposed to the fear factors, Kramer says. “Buy as selectively or as broadly as you like outside that zone, and you’ll probably outperform the market as a whole on the way back up: faster and bigger relative gains,” she says.
Meanwhile, investors should use periods of market calm to make a plan. “You need to be prepared ahead of time, so do your homework and create a list now so you can take advantage of the ‘sale’ and not be caught unprepared when the opportunity arises,” Zaccarelli says.
One of the most important things an investor can do to maximize their investment returns is to make sure their investment plan matches their objectives and risk tolerance, he says.
[Read: How Will Robo Advisors Impact the Future of Investing?]
“Commit to that plan and don’t panic when markets go through periods of volatility. Be patient,” he says. “The largest investment returns come when many people least expect it. Despite the inability to forecast stock market returns on a month-to-month or year-to-year basis, if history is any guide, the longer you remain invested in the market, the more likely you are to realize gains.”
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Why October is Crash Month on Wall Street originally appeared on usnews.com
