CHAPEL HILL, N.C. — Stock-market investors should prepare themselves for a wild ride in coming weeks.
I say that not because I have any special insight into all the things that could sabotage the stock market in coming weeks—everything from an escalating trade war to political turmoil in Washington. Instead, my prediction is based on something far less inscrutable: The calendar.
October is just around the corner.
As you can see from the accompanying chart, the stock market historically has experienced well-above-average volatility in October. The difference is quite significant, as judged by a measure of volatility known as the standard deviation: For all Octobers since 1896, when the Dow Jones Industrial Average DJIA, -0.68% was created, the standard deviation of the Dow’s daily changes has been 1.44%. That compares to 1.05% for all months other than October.
You might think that this difference is caused by a few outliers, such as the 1987 crash (which, of course, occurred in October) or 2008 (the Dow suffered several thousand-point plunges that month as it reacted to the snowballing financial crisis). But you would be wrong: The standard deviation of daily Dow changes is much higher in October than other months even if we eliminate 1987 and 2008 from the sample.
Note carefully that October’s above-average volatility doesn’t have to translate into below-average returns. On the contrary, when ranked according to average monthly returns, October is 8th. The worst month for average performance is September, and yet the standard deviation of daily changes in that month is barely above average—and well below October’s.
Why would the stock market in October experience above-average volatility? One clue comes from the above-average number of bull markets that began in October. Of the 35 bull markets since 1900 in the calendar maintained by Ned Davis Research, eight got their start in October. That’s twice as many as began in any of the 11 other months of the calendar.
How can you take advantage of higher volatility? One way, for traders only, is to bet that the CBOE’s Volatility Index VIX, -1.07% will rise. An investment vehicle for such a bet is the iPath S&P 500 VIX Short-Term Futures ETN VXX, -0.07% Though it is currently trading for its lowest level since January, it will soon rise if October experiences higher volatility.
For longer-term investors, the investment implication is not to get spooked by October’s volatility. Chances are that it doesn’t represent the beginning of a new bear market. In fact, of the 35 bear markets on the Ned Davis Research calendar, only one began in October—which is below what you’d expect on the assumption of randomness.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com.
