October a Bad Month for the Stock Market

But no one knows why – Why do bad things happen? The poet T.S. Eliot said that “April is cruelest month,” but for stockbrokers, it has always been October (Despite the fact that THIS October has been one of the best ones for the stock market in years). This month ushers in the fourth financial quarter of the year and it often brings financial meltdowns with it. Why is the tenth month of the year more prone to stock market crashes than others?

Economics professor Stephen Williamson says there’s little evidence to support that the next big crash will occur this month just because the last three major crashes happened in October. He says, “Stock market crashes have occurred sufficiently infrequently in history that there is not enough evidence on when they are more likely to occur.”

Nevertheless, he has three theories on why the stock market might tend to crash in October.

The first is the Spurious Correlation Theory. Williamson says, “Crashes could be completely random events, and if there are few of them, there is a high probability that all of them will occur in October (or April or June or whatever).”

An example of a “spurious correlation” or random events is this: “I could observe the behavior of 100 dogs. Suppose that I get 100 people to watch the 100 dogs for a week, and every morning just before the stock market opens, these people observe whether the dogs are scratching themselves. Chances are that I will be able to find one of these dogs (call him George) who will have scratched himself every day when the market went up, and did not scratch himself when the market went down. Now, I would certainly be considered a fool to bet on the stock market going up on days when George scratches himself. In the same way, I might be foolish to bet on stock market crashes in October.”

The second is the Ripening Pumpkin Theory: “It could be that there is something fundamental about October that causes crashes. Could ripening pumpkins cause market crashes? Is there something in the air from falling leaves that weakens financial fundamentals? Not likely.”

So we’re left with the Sunspot Equilibrium Theory: “In some economic models, there can exist a ‘sunspot equilibrium,’ which has the feature that, if everyone coordinates on some observable event that does not matter in any fundamental way (like October), then this can have an influence on real events. For example, it could be that, if everyone believes that October is a bad month for the stock market, then this is a self-fulfilling prophecy. General pessimism drives down the stock market for no good reason. There are some special conditions required for sunspot phenomena. This is a possibility, but I don’t think it’s likely.”

So why DOES this happen? If an economics professor doesn’t know, we’re not likely to figure it out either, but if Williamson had to choose, he says he would put his money on the Spurious Correlation Theory. In other words, it’s just a coincidence (or what we might call a synchronicity).

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