J. Lyons Fund Management, Inc. Newsletter

October 2011
Posted September 29, 2011

October: Stock Market Cortisone

Despite its dismal reputation, October has often provided a much needed "shot in the arm" to the stock market.

If you are a sports nut like us, you know this is a great time of year. Not only is baseball nearing the post-season, but
the NFL and college football are really kicking into gear. On top of that, the hockey and basketball seasons are about to get underway. With the crisp autumn air moving in and the leaves on the trees changing colors, this exciting time in the sporting world can probably be summed up in two words: cortisone shots.

For those unaware, cortisone is a steroid that is often injected into ailing body parts in the hopes of reducing inflammation, thus relieving pain and improving functions, albeit temporarily. Whether admitted or not, the issuance of cortisone shots is not an uncommon practice in football, especially as the season progresses. The pounding these athletes take can make it difficult to even get out of bed, let alone perform on the field each week. Even those baseball players fortunate enough to be in the thick of a pennant race can be severely worn out from the 162-game season. Cortisone shots can give athletes, or anyone who is ailing for that matter, a shot in the arm (so to speak) and provide a boost to their comfort level and their performance.

Yes, this is leading somewhere. The month of October is much maligned historically as it relates to its track record in the stock market -- and deservedly so. The two worst crashes in history, 1929 and 1987, occurred in October. Over one quarter of all crashes that we identified in the past 90 years occurred during the month of October. Several recent Octobers experienced crashes or panics, including those in 2008, 2002, 1998 & 1997. In fact October has by far the largest average drawdown (intra-month loss from the end of the previous month) of any month. On average over the past 100 years, the Dow Jones Industrial Average has lost -4.6% at some point during the month of October.

Average Drawdown
July -2.83%
December -2.96%
April -2.99%
January -3.12%
March -3.22%
February -3.30%
June -3.53%
August -3.65%
November -3.74%
May -3.78%
September -4.25%
October -4.64%

Yet, as paradoxically as it sounds, October has also provided a boost for the stock market more so and more often than any other month. So while our commentary often has a bearish slant, at least on a secular or longer-term basis, and while events unfolding globally make it feel as if the world is coming to an end, there is a bright side. October very well may provide a cortisone shot for the stock market. Let's look at some of the evidence.

Post-Crash Update

Let's first revisit last month's post-crash study to see how this market is tracking typical post-crash behavior and to see if we can glean any clues as to what October may have in store. As we determined in that study, the most similar crashes to the recent one, and thus most relevant comparisons, were those which A) took place during secular bear markets and B) began from within 10% of a 52-week high in the market. This table shows the average performance of the Dow Jones Industrial Average after such crashes along with the performance of the current market after the August 10 crash low.

Post-Crash Returns during Secular Bear Markets 1920-2011

1 Month
3 Months
6 Months
1 Year
2 Years

Average Post-Crash Return (when starting within 10% of 52-Wk High)
3.0% 5.8% 6.0% -0.3% 1.6%

Current Post-Crash Return
(crash low = August 10)

J. Lyons Fund Management, Inc.

As shown, the market has had a tendency to bounce fairly solidly after a crash, at least over the subsequent few months. These figures are simply averages and merely provide a loose guide for what to expect post-crash so it would be foolish to expect the market to precisely track the historic averages However, one month after the recent crash low on August 10, the Dow stood 2.5% higher than its low so the return was about in line with the typical post-crash performance.

The next benchmark is three months out when post-crash markets have averaged a 5.8% return from the crash low. That would be around the 10th of November so we can revisit this tracking at that point. If the market exactly tracked the average returns, measuring 5.8% from the August 10 low would put the Dow at 11,342. With the Dow trading around 11,000 currently, not to mention having already traded up to 11,700, that is not a far-fetched goal. Nor is it that helpful...unless the Dow is moving up to 11,342 from a much lower level than it is currently at. Thus, let's introduce post-crash drawdowns into the analysis.

The following table shows the average post-crash drawdowns, that is the largest loss from the crash low, versus those of the current market after the August 10 crash low.

Post-Crash Drawdowns during Secular Bear Markets 1920-2011

1 Month
3 Month
6 Month
1 Year
2 Year
Average Post-Crash Drawdown -3.4% -7.5% -13.8% -21.0% -28.8%
Current Post-Crash Drawdown
(crash low = August 10)

J. Lyons Fund Management, Inc.

Again, the only benchmark reached thus far in the current post-crash environment is one month. Whereas the market has historically fallen an average of 3.4% below the crash low at some point in the month following a crash, the Dow never did fall below the August 10 low in the subsequent month.

Not that we necessarily like to talk hypotheticals, but let's consider the 3-month average drawdown. If the current market were to reach the average 3-month post-crash drawdown of -7.5% below the August 10 low, it would put the Dow at 9916 (which is in the vicinity of the 2010 summer lows, incidentally). Now if we consider again the move to 11,342, but start it from a hypothetical drawdown low of 9916, that yields a 14% move. That is nothing to sneeze at.

Of course A) these are hypotheticals and B) they are based on historical averages. We obviously cannot expect the market to precisely follow this path. However, considering October's propensity to deliver sizable intra-month drawdowns and the propensity for markets to bounce firmly over the course of several months following a crash, October could very well provide an attractive buying opportunity for investors.

The October Bounce

More October-as-cortisone evidence comes from the month's historical tendency to provide a bounce, regardless of whether a crash has recently occurred. We have documented October's title as king of the monthly drawdown, however there is a flip side to that distinction. The market has historically shown a strong tendency to bounce after October, at least for the next several months. The bounce tendency is so strong in fact that October ranks first out of all months in terms of the average 3-month forward return.

Average 3-Month
Forward Return
October 3.15%
May 2.57%
November 2.35%
September 2.28%
February 2.07%
April 1.91%
January 1.84%
March 1.71%
December 1.58%
June 1.36%
July 0.03%
August -0.06%

Furthermore, integrating the intra-month drawdown into the 3-month forward returns yields an even more impressive potential boost for October. Naturally, if you add the largest drawdown to the largest 3-month forward return, the gap between October's already top-ranked average forward return with that of the other months widens further.

Average 3-Month Forward Return from Drawdown Low
October 8.48%
November 7.11%
May 6.81%
April 6.42%
December 6.16%
March 6.08%
January 6.08%
September 5.88%
February 5.56%
June 5.47%
July 4.59%
August 4.53%

October Bottoms

Now that we have hopefully removed some of the prevailing "end of the world" thinking, we have yet more cause for October optimism. There is historical evidence in favor of the stock market making significant bottoms in October when trading at 1-year lows. Now naturally the following studies are only relevant if the market does indeed trade at a new low in October. However, considering the fact that markets are within a few percentage points of a new low (some indices are already there) on top of the post-crash and October drawdown stats documented above, it is not a great leap to imagine that we will see a new low for the current move some time next month. The good news is that if that happens, the market has a decent shot at putting in a significant or semi-significant bottom, depending on the dosage of cortisone that is used.

Heavy Dose

With a heavy dose of cortisone, we could put in a bottom that would last a year or more. In the past 100 years, there have been 24 months during which the stock market A) traded at its lowest level in over a year and B) put in a bottom that would last for at least one year going forward. Of those 24, an surprisingly disproportionate 8 of them occurred during October. No other month put in even half as many bottoms.

# of Times the Market Made a Bottom for the Prior and Subsequent 1 year
January 0
February 1
March 3
April 2
May 1
June 3
July 2
August 1
September 1
October 8
November 0
December 2

That's encouraging news but also incomplete. In order to judge the true worth of the numbers, it is also important to know how many times the market traded at a 1-year low in October and did not put in a bottom for the subsequent year. As it turns out, there have been a total of 16 years in which the market has traded at a new yearly low in October. Since the market bottomed for one year 8 of those times, the other 8 times, the market failed to do so. So it is a 50-50 proposition which actually is a pretty impressive showing, particularly when compared with other months.

# of Times the Market Traded at a Low for the Prior 1 year # of Times that Low Held for the Subsequent 1 year
January 4 0
February 7 1
March 11 3
April 8 2
May 11 1
June 13 3
July 10 2
August 12 1
September 16 1
October 16 8
November 9 0
December 8 2
Total 125 24

Considering the market only puts in a bottom for the subsequent year about 1 out of every 5 months when trading at new low for the prior year, the 50% success rate for October is pretty good. No other month even had a 30% success rate. Of course the market, again, does need to trade at a new low for the year in October for these figures to kick in. The figures above provide more fuel for that outcome however when considering that the market did trade at a new one-year low in September on a retest of the August 10 low. Judging from a historical perspective, it would be very unusual for the market to have made a bottom in September that will last for the next year. Only once in 16 times (a 6% success rate) did the market trade at a one-year low in September and not go on to make a lower low during the year.

Low Dose

Even if the market does not bottom out for the next year, a low dose of October cortisone could still provide a shorter-term boost to the market similar to the post-crash statistics we looked at above. Of the 8 Octobers when the market has traded at a one-year low and did not form a bottom for the subsequent year, 3 of them put in a low that held for at least the next 2 months. The other 5 all put in at least temporary lows by December.

Of all 16 instances that saw one-year lows in October, the 3-month average return going forward was +7% and the average 1-year return going forward was +13%. Only 3 of the occurrences saw negative returns for the subsequent three months and three were negative one year out.

The Caveats

Like many of the studies and comparisons that we look at, we would be remiss if we did not consider what effect the secular (long-term) market environment had on October's ability to put in a durable market bottom. Since we have been in a secular bear market since 2000, comparisons with previous October market behavior during secular bears carry a little more weight than secular bull October comparisons. Indeed, it does mitigate the optimistic results somewhat, both in the tendency to form a bottom as well as the average subsequent returns.

October Bottoms by Secular Market Environment

# of Times the Market Traded at a 1-Year Low # of Times that Low Held for the Subsequent Year Average 3-Month Return
Average 1-Year Return
Secular Bull Octobers 5 5 11% 25%
Secular Bear Octobers
11 3
J. Lyons Fund Management, Inc.

Octobers during secular bear markets were not nearly as apt to put in a durable bottom as their bull counterparts. Additionally, the forward returns were much better in secular bull markets than during secular bears. However, there is still hope for the near-term. 5 of the 11 bear market Octobers put in at least a 2-month low while 3 of them put in lows that held for one year. Plus the average 3-month return of 5% is still a pretty good performance, especially if you include the additional gain of bouncing from the drawdown low.

That point brings us to the other caveat, the duration of October's positive boost. One characteristic of cortisone shots is that they typically provide only temporary aid. After a few days or weeks, the beneficial effects wear off. Similarly, our research has concluded that while October often provides a boost to the market, that boost is predominately felt in the short-term, particularly during secular bear markets. 

Incidentally, one drawback to cortisone is that it weakens the tissue and in the longer-term, it can actually end up doing more harm than good. While this has no parallel to October market bounces, it does bring to mind certain fiscal and monetary policies like leveraged bailouts and perpetual quantitative easing. Just saying.


We had several impetuses for writing on this topic. First of all, we wanted to write something positive, not simply as a reflection of our contrarian investment nature but also in part to counter some of the popular "end of the world" attitude out there. While there is good reason currently, both economically and market-wise, for this prevailing pessimistic sentiment, there comes a time when the sentiment becomes too one-sided. As we have said many times, the crowd is always wrong at important inflection points in the market. When too many investors become bearish on the market, that typically means that they have sold their stocks or hedged their portfolios. Eventually there is nobody left who needs to sell anything and the only direction the market can go is up. We are approaching that condition now so it fits right in with the potential for October to provide a boost to the market.

While we have had a tendency in recent years to tilt to the bearish persuasion in our market commentary, we make no apologies for that. Considering the fact that we have been mired in a secular bear market for 11 years, the environment has warranted that. On top of that, with the perpetually bullish voices permeating the investment media and industry, someone needs to be a voice for reason and reality.

Additionally, a good money manager needs to be flexible. Markets go both up and down and opportunities can present themselves in either direction if you have an open mind. Most managers disregard the "down" part of the equation. Those are the ones that have gotten stuck with 50% losses twice in the past ten years. So while we may have been negative on the market more than most in the past decade, we don't want to be seen as disregarding the "up". We are in no way "permabears", i.e., always bearish. We are just realistic. And in fact, the investment decisions that we make are derived from our purely-objective models, not from any preconceived attitude toward the market. If our models indicate the market is risky, we will make an effort to avoid that risk. If they indicate that markets are attractive for investing, we will do so.

Regarding October cortisone, the evidence is fairly compelling that some sort of low will be put in during October or shortly thereafter. The question is at what level does the market make its low? You may have to be patient and wait for that cortisone shot that October has so often provided. However, the odds are significant that a low will be put in from which at least a several-month rally can emerge. Will you or your advisor/manager be prepared for the opportunity when it comes? Investors who have been fully invested these past few months even through the crash will find it very difficult to remain objective and ready to take advantage of a potential bottom should the crash lows fail to hold. Just understand that there is no reason that a portfolio needs to incur heavy losses associated with such drawdowns. Any decent investment manager with risk controls should not have their clients' portfolios heavily exposed to equities in such a risk-laden environment, particularly if the August 10 lows are broken and the aforementioned drawdowns occur. The ability to avoid incurring big losses will allow you to resist becoming overtaken by fear and enable you to take advantage when markets present opportunities like the October cortisone shot.

Dana Lyons
Vice President

Copyright (C) 2011 J. Lyons Fund Management, Inc.  All rights reserved.


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