Wall Street finally bid good riddance to what one professional stock investor dubbed “Red October.”
In a tumultuous month marked by big price swings, rising fear levels and emerging risks, the U.S. stock market suffered its biggest October decline since the 2008 financial crisis, prompting shaken investors to reassess the staying power of a bull run that began more than nine years ago.
While the 6.9 percent drop suffered by the broad Standard & Poor’s 500 stock index didn’t come close to some of October’s best-known meltdowns – such as the nearly 20 percent fall after the 1929 crash or the record 21.8 percent plunge in 1987 triggered by “Black Monday” – it was still big enough to shatter a long period of market calm.
Despite a market rally in the final two days of the month that trimmed losses, the return of volatile markets refocused investors’ attention on the growing risk of an economic downturn and slowing profit growth for U.S. companies caused by rising interest rates, negative fallout from the U.S.-China trade dispute and political upheaval around the globe.
The recent stock slide also sparked debate about what happens when the calendar flips to November. Was the big market drop just a temporary setback or the start of a bear market?
In a report titled “Red October,” Tom Stringfellow, chief investment officer at Frost Investment Advisors in San Antonio, Texas, noted that there were few places for investors to hide to avoid losses.
More Money: Stock market: Should investors fear a correction, or 10 percent drop?
More Money: Stock market: 5 ways to keep Dow losses from scaring you and messing up your financial plan
More Money: Stock market: How to avoid investment mistakes when Dow swings up and down
The October swoon garnered a lot of attention because it briefly knocked the S&P 500 down more than 10 percent from its September high a few times in recent days, pushing it into so-called “correction” territory for the second time this year. It finished the month 7.5 percent below its recent record.
Suffering the brunt of the losses were shares of companies that had been the market’s most-popular and best-performing stocks, including the so-called FAANG stocks – such as Facebook, which fell 7.7 in October; Amazon, which plunged 20.2 percent; and Netflix, which shed 19.3 percent. Shares of home builders and companies that sell discretionary goods to Americans also suffered big losses.
What held up the best? The traditional “defensive” parts of the market, such as utility companies that provide electricity to homes, and businesses that sell everyday consumer staples such as toilet tissue, toothpaste and groceries.
For the market to stabilize, Stringfellow says it must get past the coming midterm elections, hope for a “cease-fire” in the trade war between the world’s two largest economies and keep an eye on next week’s Federal Reserve meeting to see if the central bank may consider slowing its pace of interest rate hikes.
Is the worst over?
After a two-day 2.7 percent rebound for the S&P 500 and a surge of more than 670 points for the Dow Jones industrial average, investors are now trying to gauge if the selling is over.
The message is mixed.
Some investment pros won’t rule out further declines, noting that the average market drop in the 22 corrections since World War II is more than 13 percent. “So more downside wouldn’t be surprising,” says Joe Quinlan, chief market strategist at U.S. Trust. His biggest concern is tension between the U.S. and China, which could upend markets if the tussle over trade worsens.
Still, given the continued strength of the economy, which grew 3.5 percent in the third quarter, and cheaper stock valuations after the sell-off in stocks, “the bear will stay in hibernation,” Quinlan says.
The odds of a bigger decline, or even a bear market, however, could tick up if the Fed makes a “policy mistake” and boosts borrowing costs too high and chokes off economic growth and causes a recession, says Paul Hickey, co-founder of Bespoke Investment Group. Any hints from the Fed that it is considering slowing its pace of rate hikes, however, would be viewed positively by investors.
More gains ahead?
Market optimists counter by saying that the market’s recent downdraft was overdone and that the market will mount another powerful rally. The market’s underlying health is better than recent selling suggests, they add, because the economy is far from recession and Wall Street is moving into what historically has been a seasonally bullish period.
In the past 50 years when corrections weren’t followed by a recession, the S&P 500 was up 18.5 percent on average six months later, according to David Bianco, chief investment officer at Deutsche Bank. He told clients he doesn’t see a recession next year.
Another positive for markets, oddly, is how much most stocks declined. The number of stocks in the S&P 500 and small-company Russell 2000 that fell below their average prices for the past 50 and 200 days was so great that it suggests stocks got “massively oversold” and are poised for a big rebound, according to an analysis by Tom Lee, co-founder and head of research at Fundstrat Global Advisors in New York. Since 1990, the market rallied 19 percent on average in the six months after similar readings, Fundstrat says.
“The bottom is here,” Lee said, referring to a market low.
Another reason for optimism is the fact that the S&P 500 has never been down in the 12 months following the 18 midterm elections since 1946, according to LPL Financial.
If the recent carnage turns out to be just a correction, buying opportunities will abound.
David Kotok, chief investment officer at Cumberland Advisors in Sarasota, Florida, started snapping up beaten-down stocks Tuesday after he concluded that the selling and investor pessimism had hit extreme levels.
“We’ve become buyers,” he told USA TODAY.