October is the Most Dangerous Month
The prospect of steep market declines worries investors – and the month of October has a particularly bad reputation in this respect.
Bad juju month: Statistically, October is actually not the worst month on average – but it is home to several of history’s most memorable crashes, including the largest ever one-day decline on Wall Street. A few things worth noting about 1987: 1. the crash did not presage a recession. 2. its extraordinary size was the result of a structural change in the market, as new technology, new trading methods and new hedging strategies were deployed. 3. Bernie (whoever he was/is) got six months.
Regarding point 2: in particular, the interplay between program trading and “portfolio insurance” proved deadly (the former describes computerized arbitrage between cash and futures markets, the latter was a hedging strategy very similar to delta-hedging of puts, which involved shorting of S&P futures with the aim of making large equity portfolios impervious to losses – an idea that turned out to be flawed). Too many investors tried to obtain “insurance” by selling index futures at the same time, which pushed S&P futures to a vast discount vs. the spot market. This in turn triggered selling of stocks and concurrent buying of futures by program trading operations – which put more pressure on spot prices and in turn triggered more selling of futures for insurance purposes, and so on. The vicious spiral produced a one-day loss of 22.6% – today this would be equivalent to a DJIA decline of almost 5,000 points. Due to circuit breakers introduced after 1987, very big declines will lead to temporary trading halts nowadays (since 2013 the staggered threshold levels are declines of 7%, 13% and 20%; after 3:25 pm EST the market is allowed to misbehave as it sees fit). Interestingly, program trading curbs were scrapped again.
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