Crash? What crash?

In popular folklore, October is the month of stockmarket crashes. That was true in 1987, when markets fell by a third in under a week, and in 1929, when the Wall Street crash marked the onset of the Great Depression.

But Yardeni Research reminds us that that is a myth. Statistically, September is the worst month for stocks and October only the seventh worst since 1950.

October is a turnaround month

Others observe that October is the “bear killer,” marking lows in 1974, 1990, 1998 and 2002. According to the Stock Trader’s Almanac, October turned the tide in 12 post WW2 bear markets.

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“Mid-term election years usually see major bottoms in the fourth quarter”, it says, “and November is Nasdaq’s best month in mid-term years”. Furthermore, “the six months from November through April have generated an average return of 7.4% in the Dow Jones index versus a 0.6% average gain from May to October.”

The average performance over three, six and twelve months for the S&P 500 following the mid-term elections in the last 80 years has been 7.6%, 14.1% and 14.9%.

Perhaps a better description of October is that it is a turnaround month, bullish when the market has been weak in the year to date, bearish when it has been strong. October marks the month when, for better or worse, investors and analysts start thinking that corporate earnings for the current year are in the bag and next year is becoming visible.

If earnings are rising, the current year price/earnings ratio will drop in January and that can be anticipated in the fourth quarter, but if earnings growth is on the skids, investors realise that they have a year to wait before earnings recover or grow.

That makes the third quarter earnings reporting season, now underway, important. There was a fear that companies would be reducing expectations, perhaps sharply, in the light of the economic uncertainties of 2023 but that has not been the case.

Yardeni says that the reporting season “is off to the weakest start since Q1 2020” but revenues have still been 1.1% ahead of forecasts and earnings have beaten estimates by 5.7%.

Earnings are proving remarkably resilient

Moreover, year-on-year growth is still just about positive while, so far, there have been some notable positive surprises but no shocks, as there were earlier in the year.

Bank of America’s share price has risen 15% due to better-than-expected fixed interest trading resulting in earnings, though down 5% year on year, at the top end of expectations. “Our US consumer clients remained resilient with strong although slower spending levels and maintained elevated bank deposits,” it said.

More remarkably, Netflix, which severely disappointed the market earlier this year with news of rapidly slowing subscriber growth, has seen a remarkably quick turnaround in its fortunes. In the third quarter, it added 2.4 million paying subscribers, 1.4 million ahead of expectations; revenue rose 6% and margins reached 19%. The launch of its cut-price with-ads service is imminent, though that may cause some current subscribers to trade down. The shares jumped 13%.

Those predicting that Tesla will fall flat on its face will have been dismayed by a 56% year on year increase in revenue and an 85% increase in operating profits. We have yet to see whether an advertising slow-down is affecting Meta (Facebook) and Alphabet (Google) and much else besides but so far, so good.

Resilient profits will count for little if bond yields continue to rise but a current ten-year Treasury yield of 4.25% should be close to the top. The Federal Reserve is scheduled to raise interest rates by 0.75% to 3.75%-4% at the start of November and has indicated another 0.5% six weeks later. Growing evidence of an economic slow-down should persuade it to relent either later this year or early next.

A peak in bond yields, moderate valuations (15 times prospective earnings) and earnings that are better than feared should be a positive trigger for equities.

Equities still look attractive

Equities elsewhere on lower valuations look equally attractive; in Europe, the stockmarket has never been a proxy for economic activity, emerging markets have not been plunged into crisis by a soaring dollar and the Japanese market is cheap and has been resilient.

The only concern is the observation of Tan Kai Xian of Gavekal that “there is not enough fear to buy the dip”. Investor sentiment is very bearish, he says, but investors’ allocation to stocks hasn’t fallen as it did at previous turning points. “We are not yet at the point to prompt buying, but we are probably close,” he says.

Though the UK market is undeniably cheap on a single digit multiple of earnings, the economic outlook is deteriorating, gilt yields are still too low (they should be well above comparable US yields) and the chancellor has an almost evangelic obsession with raising already historically high tax levels in a futile attempt, encouraged by the Bank of England, to bail LDI pension schemes out of disaster.

The UK government’s view of the economy seems to follow Ronald Reagan’s dictum “if it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidise it.”

A very negative domestic outlook is clouding investors’ perception of the opportunities in the wider world but it shouldn’t. Investor pessimism in the UK has resulted in investment trust discounts, on average, rising from 1.5% to over 15% this year. This offers investors the opportunity to invest internationally on the cheap, with the discount providing a margin of safety if Gavekal is right and it is still a bit early.