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Mark Hulbert: September was a horrible month for shares. That is what awaits you in October.

October plays a big role in the lore of the US stock exchanges. But the month only lives up to its oversized reputation in one way: It is really particularly volatile.

Before I summarize the historical data that supports this reputation, let me first dispel two Wall Street stories about October that turn out to be myths.

Myth # 1: October is the month with the biggest trend changes

That's just not true. According to Ned Davis Research's bull and bear market calendar through 1900, October saw nine changes in the main trend in the US market. September is higher at 10, while November is the same as October at 9.

The average number of trend changes over all months is between six and seven. None of these three months deviates from the mean in a statistically significant manner.

The source of this myth could be a related belief that October is a so-called "bear killer". It's true that October ended an above-average number of bear markets on Ned Davis Research's calendar: eight, compared to an overall monthly average of three to four. But that historic fact doesn't shed any light on the US stock market this October unless you think stocks are already in a bear market.

However, the stock market could experience a trend change this October. But if you do, then not because it is the 10th month of the year.

This is important because it is human nature to ascribe meaning to random events. For example, a month ago I argued that there was no good reason to assume that September would be a bad month for the US market. My argument still stands, even though the month turned out to be tough for stocks with the S&P 500
SPX,
-1.19%
4.8% lost.

If I told you that there was no reason to expect a coin toss to result in heads, you would not conclude that I was wrong, even if the coin did produce heads. The same principle applies here.

Myth # 2: October marks the end of the six-month seasonally unfavorable period

Actually, this is not a whole myth. It's only true one year in four, and 2021 isn't one of them.

I'm referring to the famous six month and six month seasonal pattern known as the "Sell In May and Go Away" and the "Halloween Indicator". As I wrote earlier, the statistical support for this pattern goes back to the third year of the so-called annual cycle of the presidential election.

The third year of the presidential cycle is so dominated by the “Sell In May and Go Away” pattern that, if one only focuses on the other three years, there is no statistically significant difference between the May-October and November-April averages return. The underlying data is summarized in the table below, based on the Dow Jones Industrial Average
DJIA,
-1.59%
back to its founding in 1896.

Average return from November to April

Average return from May to October

The return difference is significant at a confidence level of 95%

Every year

5.3%

1.9%

Yes sir

Third year of the presidency cycle

10.7%

0.0%

Yes sir

First, second and fourth year of the presidency cycle

3.6%

2.5%

no

Keep this in mind as you hear investment advisors this month trying to pinpoint the day in October when it is best to jump on the official start of the seasonally favorable period – Halloween. Since there is no seasonal pattern as of November, there really is nothing to jump on.

October is a particularly volatile month for stocks

Now that we've got rid of these two myths, we can focus on what's true about October: It's the most volatile month on the calendar, as you can see from the graph below:

Contrary to what we saw with the Sell In May and Go Away pattern, the above-average volatility in October is not due to just one year of the presidential cycle. It was also consistent: if we cut the period since the Dow's inception in half, October turns out to be the most volatile in both the first and second halves. In addition, the month remains at the top of the volatility rankings, even if we remove from the sample 1929 and 1987 – the years that saw the two worst stock market crashes in stock market history, both in October.

I am not aware of any theoretical explanation for why October should be so volatile and would normally recommend ignoring any pattern that lacks such an explanation. However, since higher volatility can only be caused by expectation of higher volatility, there is a good chance that October's reputation for volatility will remain.

There are a few investment tips. The first is not to let the increased volatility scare you. Hold on tight and don't let your investment strategy dissuade you.

Second, for those with a high risk appetite, it might be a good idea to take a position in one or more of the exchange-traded funds that rise during spikes in volatility. The largest assets under management are the iPath S&P 500 VIX Short-Term Futures ETN
VXX,
+ 0.07%.
Note that this product (and other exchange traded products that benefit from the volatility) is only suitable for very short-term trades as these investments lose a small amount every day even if the volatility remains constant.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert ratings track investment newsletters that pay a flat fee for testing. He can be reached at mark@hulbertratings.com

Also read: Why stocks may decline in popularity as the market's “presidential cycle” enters its second year

Plus: The S&P 500 energy sector was the only haven in a raging September storm for stocks

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