Why Do We See Market Volatility in October?
The market experienced sizeable losses on Oct. 10th and Oct 11th . Does this mean that it's time to worry? What are some of the possible reasons for this pullback? And, is this to be expected this time of year?
The Effect of Midterm Elections
One explanation might be the upcoming midterm elections. Historically, over the past 21 midterm elections, presidents in power have lost an average of 30 seats in the House of Representatives and an average of four seats in the Senate. Only twice has the president's party gained seats in both chambers.
Why? Supporters of the party not in power are usually more motivated to boost voter turnout. Combined with presidents' approval rating typically dropping in the first two years in office, swing voters and frustrated constituents oftentimes seek a big change.
This kind of uncertainty can lead to market volatility, something we've termed the "October effect." This effect is shown throughout history: October has seen more one percent changes, up or down, than any other month of the year. As a matter of fact, third quarter 2018 has shown less volatility than most, so perhaps this current pullback was to be expected.
The Role of Interest Rates
At their last meeting, the Fed raised the federal funds rate by 0.25 percent. This is the third increase this year, and their guidance suggests future rate hikes.
Investors fear that rising interest rates and increased expenses may start to erode company profits next year. And while corporate earnings were inflated this year and GDP grew by 4.2% in the second quarter, these increases may be temporary given the large tax cut.
What factors are pushing the Fed to raise interest rates? Wages have made modest gains. The consumer price index (CPI) is anticipated to go up 2.4 percent, due to higher energy costs which aren't expected to stay that way.
Additionally, the rising deficit is an ongoing concern. However, is the deficit itself the problem, or is the concern about it causing the problem? Some economists think it won't grow much more unless another tax cut or large spending bill comes out of Congress.
So what does all this mean to you? Many investors are terrible at trading—that is, they aren't experienced at predicting short term swings in the market.
For instance, if an investor stayed fully invested in the S&P 500 from 1995 to 2014, they would have had a 9.85 percent annualized rate of return*. If trading resulted in them missing the ten best days during that same 19-year period, annualized returns would collapse to only 6.1 percent. Missing these days does damage because the missed gains didn't have a chance to compound over the remainder of the holding period.
We believe that finding the right allocation to stay invested and riding out volatility can be a key to success.
*Past performance is no guarantee of future results.