Daily Gains Letter

How to Prepare for the “October Effect” in Key Stock Indices

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Key Stock IndicesOctober has just begun, and it’s one of the most interesting months for key stock indices. In the past, some of the major crashes occurred during this month. For example, on October 19, 1987, key stock indices, like the Dow Jones Industrial Average and the S&P 500, witnessed one of the biggest daily declines. But that’s not all: we also saw a pullback in October of 1989, followed by another glitch in October 2002. And who could forget October 2008? As you can see, October isn’t only scary for those who go out trick-or-treating; investors are fearful as well.

Looking at historical data, here’s how the key stock indices have performed in October.

The average return in October on the S&P 500 from 1970 to 2012 has been 0.54%. The highest return on the S&P in the month was in 1974, increasing more than 16%; the lowest return was in October of 1987, when the index dropped more than 23%. If we take out the two extremes, then the average return in the month of October on the S&P 500 since 1970 is 0.73%. (Source: “Historical Price Data,” StockCharts.com, last accessed October 2, 2013.)

For the Dow Jones Industrial Average, the average return in the month of October from 1970 to 2012 is 0.4%. The highest return achieved was in 1982, when the index increased 10.65%, and the lowest was in October 1987, when the index declined more than 23%. If we take out both extremes, the average on the Dow Jones Industrial Average since 1970 is 0.72%. (Source: Ibid.)

Dear reader, what I have mentioned are a few of the statistics that can be calculated using past data. You have to keep in mind that the key stock indices can show erratic movements, and the returns differ from one year to another. Basing investment decisions on this information may not just be faulty, but it can also harm your portfolio dearly.

On the fundamental side, there are a few moving parts going into the month. As a result, key stock indices can see wild swings.

The U.S. government is currently in shutdown mode, which could change as soon as today or tomorrow—looking at the history, these shutdowns usually don’t last very long. We should keep in mind that the debt limit debate is still on the table; a lack of decisions and/or clear direction has given the key stock indices jitters.

To compare, the last debt ceiling debate in 2011 resulted in a downgrade of the U.S. debt by Standard & Poor’s Rating Services, creating a little uncertainty on the key stock indices. Will this time be the same?

Another source of disruption can simply be the performance of the key stock indices. In the first nine months of the year, key stock indices like the S&P 500 have increased about 18%. Some doubt its rise and question its basis, as the fundamentals aren’t as strong. The U.S. economy grew at a pace of 2.5% in the second quarter, and don’t be surprised to see it slow even further.

No matter what happens on the key stock indices this month, long-term investors should remember to assess their risk. They also need to remember that while key stock indices will swing up and down over the short term, they have to keep their focus on their goals and not jump to conclusions.

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