October stock market slump brings pain but also opportunity

NEW YORK -- The bloodletting in the stock market the past month is a reminder of why October is a hall-of-famer when it comes to crashes.

For investors, October sits like a sharp curve in the road that must be approached with care. In good years, investors might grow nervous but ultimately pass safely, while in a year like 2008, October can be treacherous. But the month that brought the 1929 crash and 1987's Black Monday can also help change the stock market's fortunes.

Wall Street's latest plunge gives this October the dubious distinction as the worst of any month in 21 years for the Standard & Poor's 500 index, the market barometer professionals rely on and that is a yardstick for many mutual funds. The index fell 16.9 percent. But while that's bad, many investors have seen worse -- in October 1987, the S&P 500 logged a 21.8 percent drop.

And it's been 79 years since the torrent of selling that began Oct. 24, 1929, and intensified the following week to bring about the crash that helped kick off the Great Depression. Oct. 28 and 29 of that month have since become known as Black Monday and Black Tuesday and that plunge left the S&P down 19.9 percent for the month.

Despite its reputation as a troublemaker, October can pay huge rewards for those who survive the occasional fires. It has launched the reversal of 11 bear markets since World War II, according to the "Stock Trader's Almanac."

It's not easy to stick around after a scare, but those who do can buy stocks cheap and then score some nice gains over time.

"This is the buying opportunity of someone's lifetime," said Joe Barrato, director of investment strategy at Arrow Funds.

He notes that while it's impossible to know whether the market formed a bottom when it hit its recent low Oct. 10, as some market watchers speculate, investors should be aware that historically, the run-up afterward can be huge. Since 1926, the worst 12-month periods for the market -- not just the worst calendar years -- have been followed by enormous advances. The average return in one year after the market has logged its most gruesome runs is 35.2 percent.

By comparison, Barrato notes that those investors who shifted into bonds after the most painful stock market routs saw an average return of 5.4 percent a year later.

"People sell at the bottoms and buy at the tops and that's why they consistently underperform," he said.

Investors might be less prone to panic, at least in October, if they consider that many mutual funds are busy doing end-of-the-year housekeeping that, in bad years like this one, can include heavy selling. That's because funds' fiscal year ends Oct. 31 and so to avoid a tax hit for investors and to dress up their portfolios, many funds dump losing investments.

Tom Sowanick, chief investment officer at Clearbrook Financial, said the reasons behind much of the selling might be clear enough, but the force with which stocks are dumped can touch off fear that creates more selling.

"If markets are negative through the year then I think you have a bias toward having a fairly weak October because mutual funds typically do their selling in October for the tax year," he said.

"They sell and if we're already in a negative cycle, it creates even greater fear and exacerbates the move," Sowanick said.

Indeed, stocks have already had a rough 12 months: At the S&P's lowest close of the month -- the 899.22 reached on Oct. 10 -- the index was down 42.6 percent from its high a year earlier, 1,565.15.

Jeffrey Hirsch, editor-in-chief of the "Stock Trader's Almanac," is optimistic about the market's prospects. He noted that his father, Yale, first described October as "the slayer of bears" in the book's 1969 edition.

"Is October 2008 a bear killer? It's looking like that to me. I would say so. That doesn't mean that we're going to have a bull market for 10 years that's going to bring us to Dow umpteen- thousand."

He said investors' fear of October can itself cause selling.

"There has been a self-fulfilling prophecy," he said, adding "it sits at this crossroads of seasonality, the mutual fund deadlines and the portfolio restructuring."