During the summer months, western stock markets often decline due to reduced dealing levels. As traders and investors jet off on holiday, lower trading activity reduces liquidity. This in turn may lead to higher volatility and wider price ranges. This phenomenon (the ‘summer lull’) has been observed since the 1600s as traders first met in London coffee houses to make deals. This year has been no exception, with the FTSE 100 index softening in the sunshine. On Friday, 13 August, the Footsie hit its 2021 intra-day high of 7,224.46 points. Today, as I write, it hovers around 6,894.72, down almost 330 points (-4.6%) in five weeks. But what might happen next month?
Market crashes and the Mark Twain effect
Have you heard of the ‘Mark Twain effect’? It describes the phenomenon of stock returns in October being persistently lower than in other months. In Pudd’nhead Wilson, Twain wrote, “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” Of course, the great writer was being satirical, as this quote indicates that investing in stocks is always risky, regardless of the month. Yet the October effect survives — sometimes sending the FTSE 100 and the US S&P 500 into spectacular crashes.
For example, the Wall Street Crash of 1929 worsened on October 24 (‘Black Thursday’) and 29 October (‘Black Tuesday’) as US stock prices plummeted. This ushered in the Great Depression of the 1930s that only ended with the outbreak of World War II. Alas, US stock prices didn’t return to their 1929 peak until 1954 — a quarter-century later. But 1929 wasn’t the only major stock-market crash to happen in October. On ‘Black Monday’ (19 October 1987), US stocks and UK shares collapsed. In two days, the FTSE 100 crashed by almost a quarter (-23%). Likewise, during the global financial crisis (GFC) of 2007-09, October was a particularly brutal month.
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What if the October effect hits the FTSE 100?
In 35 years of investing, I’ve made just about every investing howler it’s possible to make. But, over the decades, I’ve come to learn from my mistakes. At the moment, two things worry me. First, as I sometimes say, “The steeper the gains, the steeper the risks.” Since ‘Meltdown Monday’ (23 March 2020), the S&P 500 has undergone of the sharpest and steepest rebounds in market history. In fact, it’s roughly doubled from March 2020’s low to today. Second, when valuations are pushed too high, they can make markets fragile. This pushes up volatility, periodically causing the FTSE 100 and other indexes to slump.
In one article earlier this month, I wondered whether the UK and US stock markets will have a winter of discontent. I speculated that we might see, say, a 10% correction in major market indexes in 2021, but not a full-blown stock-market crash. Of course, I could be wrong, but my strategy to cope with any coming setbacks hasn’t changed. For now, I continue to invest my family’s spare cash into value stocks (generally, FTSE 100 shares with low valuations and high cash dividends). If stock markets do go into reverse or Covid-19 mutations cause further havoc, I hope that my cheap UK shares will weather downturns better than high-priced stocks. I could be wrong, but I suspect that highly valued stocks would have further to fall if the October effect hits again!
