October stands out in stock market history owing to the fact that several large market crashes have occurred during the month. The Panic of 1907, Black Tuesday of 1929, Black Thursday of 1929, Black Monday of 1929 and Black Monday of 1987 are all examples of what has become known as the October Effect.
And true to form, the month of October 2018 provided us with a new entry to the stock market lexicon and a fresh colour metaphor: Red October. Global Stock markets certainly sunk into the red in October, with the MSCI world equity index registering its worst month since May 2012 and the S&P 500 clocking up its worst month since September 2011. Blue chip stocks in London also had a torrid time, with the FTSE 100 falling 5.1%.
The October stock market rout soured the investment outlook and dampened investor confidence. But investors have been uneasy for a while. Research we conducted this year shows institutional investors have been expecting geopolitical events to negatively impact investment performance. And financial advisers we surveyed pointed to volatile markets as the top challenge for their business in 2018.
This ongoing sense of unease is hardly surprising given the macroeconomic backdrop. Trade wars, Brexit, Italian budget woes, divergent central bank monetary policies and signs of a global economic slowdown have served up a toxic cocktail.
While these global macroeconomic and geopolitical currents have been swelling for some time, October’s alarming stock market plunge was caused by a set of US-specific triggers.
It started with US Treasuries selling off as investors bet on more Fed rate rises and was compounded by a disappointing earnings season that suggested the tech rally powering FAANG stocks to such lofty highs might be overdone. Indeed, US equity markets were hit hardest during Red October, with the tech-heavy Nasdaq Composite Index declining 9% in the month.
It is not surprising US equity markets stopped for breath amid the longest bull run in history. The stock market rally, built on a rather flimsy foundation of Trump tax cuts, massive earnings growth and record share buybacks, was unsustainable.
Fears the US economy is running out of gas also helped fuel the Wall Street sell-off, with investors fretting over Fed rate hikes, the withdrawal of fiscal stimulus and Trump tariffs.
But while the US was at the epicentre of Red October, its tremors were felt far and wide. As the old adage goes, when the US sneezes the rest of the world catches a cold – hence global stocks diving into the red in synchronised fashion.
However here in the UK we have a degree of immunisation from some of these US economic ills. The Bank of England is not embarking on the same hiking cycle as the Fed and, despite ongoing Brexit concerns, the economic outlook might not be as bleak as feared. The Office for Budget Responsibility recently upped its forecast for UK growth — music to the ears of the likes of fund manager Neil Woodford whose investment philosophy is built on the belief the UK economy will perform better than expected.
And while concerns over high valuations of US stocks have persisted for some time, many UK stocks remain considerably undervalued. Whether or not Red October will herald a shift from growth to value investing remains to be seen, but it would have certainly provided an opportunity for fund managers to go on a bargain hunting spree.
What we saw in Red October was US markets cooling off amid fears of an overheating economy. But while growth will likely be more anaemic going forward, the US is not on the verge of recession. Jobs and wage data remain strong and the yield curve is flattening but not inverting.
Furthermore, the stock market plunge was perhaps less about economic fundamentals and more about human emotions and how modern day investors behave in a climate of fear. The sell-off in US Treasuries was the spark that lit the touch paper in an already volatile and combustible environment. The subsequent market sell-off was likely exacerbated by algorithmic investment strategies and the ensuring noise notched up a few decibels by the 24-hour global news and social media cycle.
Rather than a prelude to any darker downturn, Red October was perhaps more a lesson in how financial and communication technologies can impact the investor psyche and decision-making, rendering investors more vulnerable to behavioural biases such as loss aversion.
Indeed, equity markets regained ground at the end of October. And an absence of any real surprises in the US midterm elections has seen markets rally at the start of November, with the S&P 500 and Dow Jones enjoying their largest post-midterm gains for decades.
While there is no doubt we will experience another financial crisis at some point, it is unlikely that Red October represents anything too sinister. It was, however, an early warning signal that the US economy needs to slow to avoid overheating. Trump needs to take his foot off the accelerator.
In keeping with tradition, October has once again spooked the markets. But a Halloween rally meant investors were spared any further frights and Red October can hopefully be consigned to the history books.
One test of whether Red October will inflict any lasting damage will be the occurrence, or lack thereof, of another seasonal quirk of the stock market — December’s Santa Rally.
And with a split Congress traditionally viewed as positives for equities, the recent uplift in stocks following the midterms may provide the perfect springboard for Santa to sprinkle some festive cheer on stock markets next month.