October (Not So) Surprise

November 4, 2008

Why do markets always seem to crash in the month of October? Did  you know that nine of the 20 greatest one-day percentage losses on the Dow Jones Industrial Average took place in October?  Of course, last month accounted for a few of those.

October 2008 was one for the record books. The Dow suffered two of the worst single days in its history: October 9th, closing down 7.33%, and October 15th, experiencing an even harsher 7.87% one-day drop. September wasn't much kinder, especially September 29th, when the Dow plummeted 6.98%, accounting for the nineteenth worst single-day drop in the history of the Dow.

However, the up days were just as historic. Two of the top ten biggest daily percentage gains took place on October 13th and October 28th, with 11.08% and 10.88% gains respectively. (Obviously, the media gets more excited by the largest daily point drops and gains, but it's the percentage gains that are more relevant.)

Fortunately, October ended with one of the best weeks ever for stocks, so the S&P 500 was down a mere 16.9% for the month – its worst month since October 1987.

In light of the markets' recent volatility, it's no wonder financial articles often begin with comments referencing the “worst day since” or “worst month since.” 

But the news is not all bad. Some of the headlines have even explained why our more aggressive portfolios have lost less than the market as a whole: 

“Oil Drops 3 Percent, Set for Record Monthly Slide”

 “Dollar Records Biggest Monthly Gain in 17 Years”

 “Commodities Head for Worst Month in 52 Years as Economies Slow”

We expected this kind of carnage in commodities and foreign markets, and some of our short funds have benefited from the unwinding. We were very close to selling these positions in the days before the market turned.

With headlines like these, it's no wonder mutual fund investors pulled $56 billion out of stock funds in September – even more than the $53 billion they took out of stock funds in July 2002, which was pretty close to the bear market bottom of 2000-2002. ETFs have seen major inflows recently, but much of the money's coming from non -individual investors (whom we prefer to watch for missteps more often than not).

We’re not big numerologists when it comes to the stock market. We don’t care for technical analysis, patterns (except when trying to <a href="http://maxadvisor.com/newsletter/farchives/000667.php">compare a bubble like China</a> to another like the Nasdaq,) charts, and other stock market astrology. Invest when others are scared, pull back when others are aggressive, and you’ll do fine long-term.

Having said that, when the stock market falls as hard and fast as it has over the past few weeks, it's understandably more difficult for investors to stick to their current stock allocations, much less begin to shift money from safer assets into stocks – as is our strategy.

So far, this is likely the worst market since the Great Depression. Although the S&P 500 and Nasdaq were actually down more in 2000-2003, a review of all of the fund categories (especially in foreign markets,) shows that this bear has destroyed more wealth than the previous one, largely because everything fell at once (something <a href="http://maxadvisor.com/newsletter/farchives/000691.php">we worried about</a>, most recently in April). 

In such a market, the fact that <a href="http:\maxadvisor.com\newsletter\farchives\000601.php">we said cut back on stocks</a> when the Dow plowed through 13,000 to new record levels doesn’t really matter, because some investors fear that our current strategy of increasing stocks on the way down is wrong. It feels like throwing good money after bad.

Nobody cares that the stock market often rises 20%-65% in the 12 months following a bear market. All anyone can think about is maybe this is The Big One – the Great Depression that won’t turn around for 20 years. One of our favorite headlines from the 1929 crash, printed October 26th, 1929, reads, “Letters to Clients Warn Against Hysterical Selling and Favor Some Buying.” In fact, hysterical selling would have been a good idea.

True, the stock market may continue to fall, but the more it falls, the greater the future upside. We'll continue increasing our stock allocation, and we'll reduce our short funds and safer bond funds if the market continues to collapse. The trade we made earlier this month will not be our last.

While further losses are, of course, possible, there are two main reasons we won’t see a repeat of 1929 and a 90% drop in the Dow: 

1) The stock market ran up 300% in the six years before the 1929 crash. Our recent 2007 high was 300% higher than the 1993 Dow. Expensive markets fall 50%, bubbles crash 90%.

 2) There is far too much government today and too much guaranteed income – from Social Security, savings, and inheritance, for those already in retirement. We won't see a repeat of 25% unemployment and a 25% collapse in GDP.