Should we invest in Stocks in October, Despite Seasonal Risks?

Stay in Stocks in October?

There are a number of reasons for avoiding risky assets like stocks in the month of October, ranging from seasonal to geopolitical to fundamental:

1. Seasonal: Historically, September and October have traditionally been the most volatile months of the year for stock markets worldwide, the months when most sharp stock market falls have been recorded (think Sept-Oct. 2001, Sept-Oct. 2008). Yes, stock markets have generally made small advances over the month of September, and have done well over the year to date. But isn't that precisely the reason for locking in profits now, at the beginning of October?
2. Political: The partial US government shutdown over the lack of agreement between the Democrats and Republicans over a the US budget could cause further volatility in the US economy and thus in financial markets. Thus far, markets seem to have taken these events in their stride (VIX volatility index close to a year low at under 15), but can we expect this relative calm to persist if no agreement is reached soon?
3. Fundamental: Let's not forget that the US Federal Reserve, having positively surprised the markets by not beginning the infamous "taper" (i.e. not reinvesting the proceeds of maturing bonds back into the US bond market) in September, could nevertheless begin this tapering process very soon. This was even hinted at by St. Louis Fed President James Bullard, who intimated that the taper might even begin in October (i.e. this month!). So the relief rally we have seen in bonds may not last much longer...

But some reasons to stay the course with stocks (for now)

A key reason to remain invested in stocks at the beginning of October is the basic fact that established uptrends in the major US, European and Japanese stock markets remain intact. Each stock market sits above its own 3-month and 6-month moving averages, and has not broken the general pattern of higher highs and higher lows. 

EuroSTOXX index in clear uptrend

Secondly, while it is true that September and October have contained some painful periods of stock market falls, we should not ignore the fact that, on average, the UK stock market has generated an average 2.1% total return (price change + dividends) over the two-month period over the 23 years from 1990 to 2012. 

UK stock market has gained 15 times out of 23 Sept+Oct periods

Indeed, over the past four years we have seen positive 2-month returns on each occasion... So from this simple statistic, I would say that the jury is out on whether these months should be completely avoided or not. 

Be pragmatic, use a stop-loss!

My pragmatic approach to investing in stocks at this time of year is relatively simple: I favour using liquid index-based ETFs rather than individual stocks, as then I can easily manage the level of risk in my portfolio by selling or reducing only a few investments. I also put in place a relatively tight stop-loss, so that I reduce my stock market investments before losses become painful. 

But, for this month of October, my ETF-based investment strategy is 100% invested in stocks, via UK Small-Caps (ETF code: CUKS), Euro Low Volatility stocks (IMV), US Small-Caps (ISP6), Emerging Markets Low Volatility stocks (EMMV) and FX_hedged Japanese stocks (IJPH). But in each case, I will be closely monitoring weekly moves, and selling them if they exceed the stop-loss levels I have set in place as of today. 

Year-to-date performance of my re-christened STAS

On a final note, I just wanted to point out that my asset allocation trending system STAS (Signal-driven Tactical Allocation System) has now gained 15.1% net of costs over the year to the end of September, including a monthly gain of 1.3% for September alone despite being 40% invested in cash. So far, still so good...