Did the ‘October Effect’ affect you?

Behavioural financial analyst Ken Norquay points out that October’s gruesome Hallowe’en holiday reminds us that human activity is not always rational. There is no need to lose your money just because the world around you gets weird. Long-term investors should review their investment plan, paying particular attention to their reasons to sell out of the stock market.

October_EffectEvery October, our society goes through a strange ritual involving the gruesome images of imaginary death presented Hollywood-style, with all the exaggeration and special effects of modern fantasy. How strange! We imagine that we live a sane, logic-based society. Then along comes The Hallowe’en Effect to remind us that we don’t.

As a market psychologist, I continually marvel at the complexities of the human mind. In my stock market book, Beyond The Bull, I describe how “everything’s connected to everything else”. It’s easy to see how true this concept is in the economic world. Interest rates are a lead indicator for the stock market. Inflation leads interest rates. Commodities prices lead inflation. The string of economic causes and effects is endless. But what about this complex thing we call the human mind. What are the causes and effects of our mind’s thought process? Why do we do what we do? Why do we believe what we believe? And why do we revisit the madness of death every October?

Make the story fit

The US stock market high occurred on the autumnal equinox, Sept. 21, 2018 when the S&P500 touched 2,941. It drifted sideways until Oct. 3, when the Dow Jones Industrial Average hit its all-time high at 26,952. Then, on Oct. 10 and 11, the first wave of the long-term decline began. Financial reporters looked about frantically for news about what might have triggered such a sharp decline. They found nothing but old news: trade war tariffs, the renegotiation of US trade agreements, rising interest rates. A few days earlier, China had announced that she was going to be selling another US dollar long-term bond issue. Was this the cover story the media was looking for? If this imaginary media thought process is accurate, you can see how illogical it is. The reason financial reporters scrambled for negative news is that the market went down. The sharp decline sent them scurrying for bad news. The market leads the news. The market causes reporters to look for news that matches the market’s trend.

A few weeks earlier, when the up trend extended its longevity to a new record, reporters told us positive news. A few weeks after that (Oct 10, 11), when the market dropped with breath taking volatility, they reported whatever negative news they could find. This frantic need to find a positive or negative story to match the market does not help individual investors manage their portfolios. It’s just like Hallowe’en. For eleven months of the year, we are aware that our life will end. But when October comes, we acknowledge it with a funny children’s holiday. How strange.

With the awareness that things DO end, let us examine the trends of those financial markets that most effect Canadian investors’ financial future.

October can be very scary

The US stock market averages touched new high levels recently, confirming the record-long bull market that began in March 2009. Then the wild winds of October brought a sharp drop, even as this article was being written. Try to remember what happened in February of this year: the S&P500 dropped 12 per cent from the high to the low! Scary! Hallowe’eny! Then there was October 1929 and October 1987, the months of the two biggest one-day stock market crashes in modern history. Are you scared yet?

(For the record, Hallowe’en plays with the concept of fear of death. Now I’m playing with fear of losing money. Fear is fear: our advice has always been to use reason to make investment decisions, not fear.)

The US market remains in a long-term up-trend, but the extremes of volatility in February and October 2018 are warnings that the up trend is ending. Our guess is that the long-term up-trend ended with the all-time high of the S&P500 on Sept 21, the equinox of 2018. Statistically, the up-trend won’t end until the market drops decisively below the February 2018 low: S&P500 2,533.

The Canadian stock market top occurred on Friday the 13th, July 2018, when the TSX composite hit 16,586. Statistically, the TSX is still in the long-term up-trend that began in March 2009. The July top will be confirmed when the TSX Composite Index drops decisively below last winter’s low, 14,786. (How strange that the longest ever stock market up-trends would feature a trade war.)

US long-term interest rates are in an up-trend, and have been since the summer of 2016. That up-trend was confirmed in the first week of October when 20-year+ yields rose to a new 4-year high. The up-trend has been confirmed by a similar rise in short-term interest rates.  It is interesting to watch how China plays her aces in the international poker game of trade negotiations. America is slowly waking up to the fact that her interest rates can be influenced (controlled?) by China. The Chinese sold a large tranche of US dollar-denominated long-term bonds. Their continued selling of US dollar-denominated long-term paper puts continuing upward pressure on long-term US interest rates. No part of this trade war is good for long-term investors.

Canadian long-term interest rates are in lock step harmony with those in the US. The long-term trend is up.

USD in a trendless, sideways drift

The US dollar vs. the basket of non-US currencies is in a trendless, sideways drift. This stability is healthy for the world’s banking system and for international trade. How strange that currency stability would accompany a trade war.

The Canadian Dollar vs the US Dollar has been in a slight up-trend since the oil price crisis several years ago. The long-term trend is UP.

Oil prices touched a new recovery high earlier this month, confirming that the price of energy is also in a long term up trend following the 2014-15 collapse.

Gold is in a trendless, sideways drift following its 2011 to 2015 decline.

Aside from the sharp jolts of the stock market in February and October, the financial markets seem quite stable. This seems strange in light of the trade wars. Don’t economics professors tell their students that import taxes caused the depression of the 1930s? Don’t trade embargoes accompany a political swing to the right as occurred in Europe in the 1930s? Isn’t all this happening now, and doesn’t it portend economic volatility and instability? That’s what happened in the 1930s. How strange that, except for a few jolts in the stock market, it’s not happening now.

Furthermore, this cycle’s unique economic stimuli are also disappearing. Most analysts do not report the economic stimulus associated with energy prices. Cheap oil helps oil consuming countries like the USA, Japan and Europe. The relentless increase in oil prices these past two years are reversing that stimulus.

When the US Federal Reserve Board implemented its ‘Quantum Easing 1, 2 and 3,’ it did so to juice up the US economy after the banking disaster of 2007-10. QE 1, 2 and 3 have been removed, and now China is reversing the effect of QE3 by selling USD long-term bonds.

Wall of Worry

These are the economic goblins walking the streets this October 2018. Optimistic analysts tell us these facts are merely a ‘wall of worry’ and this record long stock market up-trend will continue even longer. And, so far, they have been right.

Strategy: long-term investors should review their investment plan, paying particular attention to their reasons to sell out of the stock market. Be sure not to ‘hold’ through another wealth-destroying bear market as occurred in 2001, 2, 3, and again in 2008, 9. This time, the warning signs are much clearer. When your reason to sell presents itself, hold your cash reserve in short-term interest bearing investments and prepare to buy back the stock market at much lower prices.
Short-term traders should investigate ETFs or options that increase in price when the stock market declines.

Reminder: October’s gruesome holiday reminds us that human activity is not always rational. Sometimes we get weird. There is no need to lose your money just because the world around you gets weird. There is no need to squeeze every last dollar out of every long term financial up trend. In the money management business, they talk about ‘the prudent man rule’. They ask: “What would a prudent man do under these circumstances?” Let’s use October’s Hallowe’en as a reminder of the scary, irrational side of investing.

Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: Behavioural finance.

This is an edited version of an article that was originally published for subscribers in the October 2018/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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