As we enter a month already notorious for volatility and market crashes, an ominous brew of high-impact events lies directly ahead. With US stocks still near record highs, many are wondering if the market has reached a top and is due for a rout. Will the China/US trade talks, Trump impeachment inquiry, third quarter earnings and Brexit be the ingredients for an October perfect storm?
The October Effect
The ‘October Effect’ describes the perception that stock market sell-offs often take place during the tenth month of the year. The fact that many of the largest historical market crashes took place in October, including the Panic of 1907, the Wall Street Crash of 1929 and Black Monday of 1987, contributes to the sense of unease. The stock market crash of 2008 occurred just shy of October, on September 29th.
Research from LPL Financial suggests that October should actually be more famous for its volatility than crashes. The report points to the fact that since 1950, no other month has seen more 1% price moves for the S&P 500, while returns are roughly average. In a widely quoted note released last Friday, John Marshall of Goldman Sachs went even further back in his research, stating that since 1928 stock volatility has been on average 25% higher in October.
The equity derivatives strategist noted: “We believe high October volatility is more than just a coincidence. We believe it is a critical period for many investors and companies that manage performance to calendar year-end.”
US/China Trade War
Both stocks and the US dollar traded higher on Wednesday after President Trump stated that a US/China trade deal could be around the corner. Speaking to reporters at the United Nations in New York, he said: “They want to make a deal very badly… It could happen sooner than you think.”
Trade talks between the US and China are reportedly set to resume on October 10th and 11th in Washington. While the mood is currently cautiously optimistic, a further breakdown in trade relations will again raise fears of a global economic slowdown and roil the markets.
Trump Impeachment Inquiry
On Tuesday, Nancy Pelosi announced that the House of Representatives would initiate a formal impeachment inquiry against President Trump. The inquiry centers around an anonymous whistleblower report claiming that President Trump pressured Ukrainian president Volodymyr Zelensky to launch investigations into 2020 presidential candidate Joe Biden and his son, Hunter Biden.
Stocks sold off on the heels of the news. However, while we may see more volatility, historically impeachments are not negative for stocks. Stocks actually gained substantially during the impeachment process of Bill Clinton. Meanwhile, amid the turmoil in Washington, the US dollar was boosted by its safe-haven status.
Brexit, the scheduled withdrawal of the United Kingdom from the European Union, continues to keep the United Kingdom in a state of political chaos. The deadline for an agreement to be reached is Thursday October 31st. On September 4th, Members of Parliament voted to pass a law that would force Prime Minister Boris Johnson to request a three-month delay to Brexit to January 31, 2020 if a deal with the EU has not been reached.
However, on Thursday Sir John Major warned that the Prime Minister could use a so-called “Order of Council” to avoid implementing the legislation until after October 31st and thereby force through no-deal Brexit. The ongoing uncertainty over the future of the United Kingdom is leaving investors on the edge of their seats as the end of October deadline closes in. Bank of England Governor Mark Carney recently estimated that a disorderly Brexit would reduce UK GDP by about 5.5%.
October Federal Reserve Meeting
In July of 2019 the Federal Reserve lowered interest rates for the first time since the financial crisis of 2008. At the September meeting last week, the US central bank followed up cutting interest rates by 25 basis points to a range of 1.75% to 2.00%. The post-meeting statement cited concerns over a global economic slowdown and low inflation as justification for the move.
According to the CME FedWatch Tool, the market is currently pricing in a 44.9% chance of another 25 basis point rate cut at the October 30th meeting. Last Friday, Federal Reserve Vice Chair Richard Clarida stated that interest rate decisions for October and beyond will be made on a “case by case basis”.
The Bottom Line
August of 2019 was a volatile month for the market with 11 swings of over 1% in S&P 500. The Dow Jones Industrial Average tanked by 800 points on August 14th, marking its largest percentage drop of the year and fourth-largest point drop ever. August volatility was driven largely by mounting fears over the US/China trade war and the inverted yield curve, a reliable indicator of recession from the bond market. After a lull in volatility in September, the CBOE Volatility Index (VIX) reached a three-week high on Wednesday, as investors anxiously await the start of October.