Now That the Stock Market Made an October Low, Where Will it Go?

“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” – Mark Twain

A lot has changed in more than a century since Mark Twain first uttered his memorable quote, but with no less than 14 important stock market lows established in the month of October just since the launch of daily S&P indexes in 1928 (a disproportionately large 17% of all bottoms), it appears Mr. Twain was on to something.

Given the enthusiasm with which investors initially bid up prices on Wall Street after the S&P 500 capped a 2-month, 6% correction by sliding as low as 1168.20 in its favorite bottoming month on October 13 of this year, it appears an apparently 15th significant October trough in the benchmark average is now in place.

At http://www.gannglobal.com/ , we specialize in performing in-depth historical market research and applying it to the present. Accordingly, we thought this would be a perfect time to look at every major October low in history dating back to the advent of meaningful daily stock market averages in the 1880s, in hopes of gleaning some key insights that will help us determine if the current rally is for real and how long it might last.

Strangely, the most infamous and portentous October crash, that of 1929, doesn’t even make the list. That’s because, despite the extreme ferocity of the carnage in October, the market didn’t put in a real low until November 13, down nearly 50% from its stratospheric highs seen only a little over a couple of months before. By the end of the Great Depression, investors would long for the prices that once appeared shockingly cheap in November 1929, and the blue chip averages wouldn’t regain their former peak until 1954.

None of the markets that actually bottomed during past Octobers packed quite the drama of 1929, but some were the product of lesser crashes, as we’ll see. We generally omitted October lows that followed corrections lasting less than a month.

The bull market was already over 2 years old following a favorable end to the Spanish-American War in the month of August, when market averages attained fresh bull market highs amid widespread euphoria, much like they did last August. By 1898, Dow Jones had split its stock market barometers into separate Industrial and Railroad averages. The Industrials fell more than 15% into the October low, but the Rails, the blue-chip average of its day, corrected a mere 6%, same as our market in 2005. Before Thanksgiving, the Rails were already making new highs for the bull market, just like the S&P this year. The more volatile Industrials rocketed 50% in 6 months before their next correction. The Rails, meanwhile, would gain 32% by April 1899 – a very typical leg up in terms of both price and time for blue chips in the aftermath of October seasonal stock market lows.

This 7-month 18% correction was the biggest drop in the Dow since it lost 48% in the bear market of 1919-21. Once the correction ended, the DJIA climbed 18% into February of 1924.

As in 2005, Wall Street was also 3 years removed from a brutal bear market that saw stock prices nearly cut in half – when the benchmark blue-chip stock measure, then the Dow Jones Industrial Average (the S&P didn’t yet exist), as it did this year, bottomed in spring, climbed to a marginal new high still well short of its all-time high in August, staged a 6% correction until early October, then exploded some 25% in rocketing to a fresh all-time high by the first quarter of the next year before running into any sort of resistance. The Dow actually gained 27% to a new all-time high by March 6, 1925, before its next modest correction, which lasted less than a month.

Another case of an August high followed by a 2-month correction. The decline amounted to less than 7% in the S&P and only a little over 6% in the Dow. Despite Eisenhower’s election in early November, returning a Republican to the White House for the first time in 20 years, Wall Street could muster only a 12% rally that petered out in early January 1953. Part of the problem may have been an abundance of stops that built up when the Dow made a series of higher lows starting in November 1951. By September of 1953, the DJIA dived far enough to take out those lows and clean out the weak hands. The S&P, however, held above its November 1951 low. The divergence proved positive, and the stock market really took off starting in late 1953.

The surprise launch of Sputnik 1, the first artificial satellite, on October 4, 1957 vaulted the Soviet Union into an early lead in the space race and helped bury a stock market whose grave was already partially dug by relentlessly rising interest rates. The relatively modest 21% bear market decline in the S&P masked the true extent of the damage. Though the indexes topped in 1956, the vast bulk of the slide unfolded in a span of just over 3 months starting in July 1957 that saw many transportation and cyclical stocks (steels, aluminums) cut by 60-70%. Prices rebounded through November, before a brief dip that bottomed before Christmas. After that, the S&P went straight up until August 3, 1959, gaining a robust 56%.

After it topped on August 3, 1959, labor strikes and a mild recession helped drive the S&P 14% lower. The DJIA managed to forge a new all-time high in January 1960, before plunging 17.5%. After the market finished fully discounting Kennedy’s upcoming election victory, the S&P surged 29% in 6 months and 22 days before suffering any loss of momentum.

The short but sharp bear market of 1961-62 bottomed before the middle of the year. As in 1898, 1924 and 1952 (and 2005), a bull market rally peaked in August, only to lead to a 2-month correction, culminating this time with a cumulative decline exceeding 9% in the Dow and 10% in the S&P on news of the Cuban Missile Crisis. On the night of October 22, 1962, President Kennedy went on TV to inform the nation of the recently discovered buildup of Soviet offensive nuclear missiles in Cuba and announced a naval blockade. The next day, the S&P got hammered for a 2.7% loss. But that marked the low. Prompt resolution of the crisis allowed the Dow, in November 1962, to rack up its best month in 23 years, since the outbreak of World War II. Blue chip stocks rallied for over 7 months, through May 1963. The S&P’s gain during that interval topped 32%.

Stock investors discovered that small was beautiful after this bear market low that followed the Dow’s unsuccessful first assault on the 1000 level. Within the next year, the DJIA gained as much as 27%. The broader S&P jumped 33%. Almost half of all NYSE-listed issues gained at least 50% in 1967. S&P’s index of low-priced stocks, computed weekly, skyrocketed 87% from its bear market low by the summer of 1967, even as a separate S&P index of 25 “High Grade” common stocks struggled to a mere 22% gain during the same period. The environment was not altogether unlike today’s. It’s no secret that secondary stocks have led the bull market since 2002. In early December 2005, the S&P 400 Midcap, S&P 600 Small Cap and Russell 2000 indexes all made new all-time highs, each of them more than double their respective levels at the lows of 2002. Meanwhile, bigger stocks, as exemplified by the Dow in particular, have lagged. The DJIA has yet to match its March 7, 2005 high for the bull market, let alone its all-time high. The S&P 500, cut in half after March of 2000, remains far below its all-time high.

In 1968, the Dow was scorned as an anachronism when it alone failed to make a new all-time high in a market where everything else was going through the roof. The Dow Jones Utilities average, too, couldn’t get out of its own way amid rising long-term rates after leading the market higher in the early 1960s. Ultimately, the DJIA stalled a mere 1% short of its 1966 high, before turning sharply lower (and taking everything else down with it) in a wicked bear market. This is something to bear in mind considering that a 30% rally in the S&P from its October 2005 low wouldn’t be quite enough to propel it to a new all-time high, and the once super-inflated, tech-heavy NASDAQ and NASDAQ 100 indexes continue to trade more than 50% below their all-time peaks.

Another example of a 2-month decline from an August high that took blue chip stocks down by little more than 5%. The ensuing rally drove the DJIA to its first-ever closes above 1000, but proved short-lived. The bull market was on its last legs and could only gain less than 13% in a very narrow advance before it ran into a brick wall of tighter monetary policy and soaring inflation in January 1973.

The greater than 45% decline in the Dow Industrials in 1973-74 still ranks as the worst since World War II. The S&P leaped 21% in the first 5 weeks after the bottom, only to lose 14% in the next month. In early December, the Dow made a new low but the NASDAQ and S&P didn’t, and 1975 proved to be a great year for stocks.

The main correction actually ran from fall of 1983 to late July 1984 and knocked blue chip stocks down around 15%. The Dow and S&P then each jumped over 14% -- to highs in August and September, respectively – before slipping 5-6% into early October. After eclipsing their summer highs, the averages then sold off again into early December. The Dow sank beneath its October low, but the S&P didn’t, instead rallying 23% in over 9 months until the next correction in July 1985.

This was “Terrible Tuesday,” the day they almost shut down the stock exchange on further weakness in the wake of an unprecedented 508-point, 22.6% Dow free fall the day before, on “Black Monday,” October 19, 1987. Stocks turned around by the end of the session and have never been as cheap again. By the next day, stocks were 20% higher. The exceptional strength proved short-lived, however, and by December 4 the market gave back nearly all of its remarkable one-day-plus gain. The S&P actually made a new closing low in December, unlike the Dow, but held comfortably above its intraday low of October 20. By early January 1988, with the Fed serving up ample liquidity under new Chairman Alan Greenspan, stocks rose to new post-crash highs, before promptly commencing another sharp sell-off. That set the pattern for 1988, a year of choppy advance, marked mostly by higher lows and higher highs.

Given the spectacular nature of the 1987 crash, it’s easy to forget that the entire 36% plunge, most of it inflicted in one day, lasted less than 2 months – just like many of the more routine August-October declines witnessed in the past.

This correction lasted only about a week, but we mention it because of its extraordinary speed and unique catalyst. Friday, October 13, 1989 saw a sudden 190.58-point drop (6.9%) in the DJIA dubbed the “mini-crash” – the worst since Black Monday – on the collapse of a buyout bid for UAL, parent company of United Airlines. UAL shares got cut in half. The Dow rose to a new all-time closing high at the beginning of January 1990, while the S&P gained 10% to fall just short, only to then undergo a correction worse than the one in October.

Iraq’s August 2, 1990 invasion of Kuwait led to a spike in crude oil prices to above $40 a barrel and sparked a bear market lasting less than 3 months. The S&P bounced back 13% by early December. Blue-chip stocks remained firm through Christmas, but retreated more than 6% by January 9, 1991 on the collapse of peace talks in advance of the January 15 deadline for Iraqi withdrawal. The original Gulf War proved much more popular than the sequel, and investors responded enthusiastically once the bombing began and a decisive victory appeared inevitable.

This 2-1/2-month correction spawned by the Russian Debt Crisis and collapse of the giant, highly leveraged hedge fund Long Term Capital Management (LTCM) ranks as easily the worst of the 1990-2000 bull market. Riding to the rescue, the Fed slashed interest rates and the Federal Reserve Bank of New York organized a bailout of greater than $3.6 billion for LTCM. The S&P surged 54% in over 9 months until the next year’s July-October market correction. The bull market of the 1990s actually outlasted the misleadingly named Long Term Capital Management, which went from inception to liquidation in less than 7 years.

This low led to the final leg up for the Dow in the bull market. The S&P, which rallied 20% into January 2000 before falling for several weeks in sympathy with the Dow, would enjoy one last thrust higher in March, buoyed by still-strong big technology names.

Those big technology stocks would prove the undoing of the S&P, dragging it down 50% in the longest bear market since the 1940s. The first leg up from the 2002 bottom carried the S&P 24% higher into early December, before a severe correction obliterated the vast majority of the initial gain over the next 3 months.

October lows are nothing new in the stock market, especially following on the heels of a summer high. Some post-Thanksgiving resistance, like we’ve experienced in this year’s rally, is also fairly typical, although it rarely persists past Christmas and it would be almost unheard of to see the recent weakness last beyond early January.

At http://www.gannglobal.com/ , we’re also paying close attention to a couple of past markets that traced out patterns highly similar to the present, leading up to minor corrections in the second half of the year. After modest declines approximating what we saw early last fall, both the 1945 and 1985 stock markets surged at least 30% into the following year. We believe that the October 2005 low in the stock market will hold and, based on multiple precedents including a number of previous October bottoms, we look for a fairly “normal” 30% advance in the coming months.

James Flanagan is a well known specialist in the field of market forecasting and analysis. Using a proprietary, complete database of price history and the methods of W.D. Gann, he has been publishing his forecasts and investment research since 1990 (Past Present Futures newsletter). James oversees all of the research for the Financial, Stock, and Commodity Markets at Gann Global Financial. You can visit his website: http://www.gannglobal.com

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