Each year, the markets begin gearing up in November for the expected "Santa Claus rally," the boost in sentiment, spending, and retail sales thanks to the approaching winter holidays. This surge generally kicks off with Thanksgiving and the following "Black Friday" shopping event and lasts throughout December. In most cases, the Santa Claus rally helps the stock markets close out the year on a high note, broadly lifting fourth-quarter results for U.S. companies.
However, with the unusually strong performance during the month of October, the financial markets may have hit their peak too early, potentially leading to an abnormally "chilly" holiday season for equities.
Historically, October is one of the worst months for stocks. They even have a name for it: the "October Effect." Although the past can never be taken as a perfect indicator of future results, the trend for stocks to dip during October and post a strong rally during the last two months of the calendar year.
Not only is October an historically weak month, it has also witnessed two of the most frightening events that any trader or investor will ever suffer through—the infamous stock market crash that kicked off the Great Depression in October 1929, and the market plunge known as "Black Monday" that came on October 19, 1987.
As you might expect, in the instances when this is not the case and October sees its own Halloween rally, the market performance in the following months has typically been subdued. This year, October saw the S&P 500 advance an incredible 9% during the month.
According to research by equity strategist Sam Stovall, who works for S&P Capital IQ, whether or not October is a weak or strong month for stocks often has a high correlation to how the biggest sectors of the stock market end the year. Stovall found that, since 1945, "each increase in the size of the October advance reduced the average price gain and the frequency of the advance for the rest of the year," while the best year-end results occurred after particularly bad October performances. The chart below demonstrates this trend: the better the October, the worse the rest of the year tends to be, and vice versa.
A Trick Without a Treat?
Stovall's analysis was published under the appropriate title, "Stealing from Santa?" As his research reveals, there's a fairly strong pattern of the best gains for the fourth quarter coming either in October or the succeeding two months—but rarely, if ever, in both. While there's always the possibility that 2015 is the year that bucks the trend, investors would do well to stay informed and adjust their expectations accordingly.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.