The October Effect: Why Market Downturns Happen and How Gold Can Be a Safe Haven

As autumn leaves begin to fall, investors often feel a chill that has nothing to do with the weather. October has long been associated with market volatility and abrupt downturns; a phenomenon known as the "October Effect."

But what's behind this unsettling trend, and how can savvy investors protect their portfolios? Let's explore the October Effect and why gold might be your best friend during these turbulent times.

Understanding the October Effect 

The October Effect refers to the perception that stock markets are more likely to decline during the month of October. While not backed by strong statistical evidence, this belief has deep roots in financial history and continues to influence investor behavior.

Several of the most significant market crashes in history have occurred in October, cementing its reputation as a dangerous month for investors:

• The Panic of 1907: This severe monetary crisis shook the New York Stock Exchange, causing the stock market to fall by nearly 50% from its peak the previous year.
• Black Tuesday (1929): This market collapse marked the start of the Great Depression. In just two days - October 28 and 29, 1929 - the Dow Jones Industrial Average (DJIA) plunged a combined 25%. Within weeks, by mid-November, the Dow had shed nearly 50% of its value.
• Black Monday (1987): This crash saw the largest single-day percentage decline in U.S. stock market history. The DJIA plummeted 22.6% in one day, losing over $500 billion in value.
• Friday the 13th Mini-Crash (October 1989): On this ominous date, the DJIA plummeted 190.58 points, or 6.91%, in a single trading session. This sharp decline was attributed to the collapse of a $6.75 billion leveraged buyout deal for UAL Corporation, the parent company of United Airlines. This event is notable for occurring just four days after the major indices had reached all-time highs.
• 2008 Financial Crisis: Although the crisis began in September and lasted for months, October 2008 saw the most severe market declines. On October 15, the Dow Jones Industrial Average (DJIA) plummeted 733 points, a 7.9% drop that marked the second-largest single-day point decline in history at that time.

These dramatic events have left a lasting impression on the collective memory of investors, contributing to the October Effect myth. But what drives this persistent belief, and how does it impact investor behavior?

Psychological Impact 

These psychological factors work in tandem, creating a feedback loop that can contribute to market volatility during October.

• Anchoring Bias: Investors tend to fixate on past October crashes, leading them to anticipate similar events. This cognitive bias causes people to rely too heavily on initial information (the "anchor") when making decisions. Memories of historical market crashes serve as powerful anchors, influencing risk perception and investment choices, even when current market conditions differ significantly from those past events.
• Media Influence: Financial news outlets often highlight historical October crashes, reinforcing anxiety among investors. The media's tendency to focus on dramatic events and draw parallels between current market conditions and past crashes can amplify investor concerns. This increased coverage during October can lead to heightened market sensitivity and volatility, as investors react to both current news and historical comparisons presented by the media.
• Self-Fulfilling Prophecy: Even the expectation of a downturn can cause investors to sell preemptively, potentially triggering the very decline they fear. As more investors act on this fear by selling stocks or holding off on new investments, it can create downward pressure on the market. This collective behavior can lead to actual market declines, perpetuating the cycle.

Gold's Performance a Safe Haven During Market Crashes 

While October may bring market jitters, it also presents an opportunity for investors to consider diversifying their portfolios with gold. Historically, gold has served as a safe-haven asset during times of economic uncertainty and market volatility.

• 1973-1974 Oil Crisis: During this 23-month bear market where the S&P 500 dropped 48%, gold prices soared by 73%.
• 1987 Black Monday: While the stock market plummeted 22.6% in a single day, gold prices rose by 4.6% in the following week.
• 2000-2002 Dot-com Crash: As the S&P 500 fell 49% over this period, gold prices increased by 12.4%, offering a hedge against the tech-driven market decline.
• 2008 Financial Crisis: While the S&P 500 fell by 38.5%, gold prices increased by 5.5% over the year. More impressively, from 2007 to 2009, as the crisis unfolded, gold surged by 25.5%.
• 2020 COVID-19 Crash: Gold reached record highs later in the year as investors sought safety amid economic uncertainty. From the market bottom in March 2020 to its peak in August, gold prices rose by approximately 40%.

Historically gold has a strong track record of performing well after a crisis. The following graph shows the nine biggest crashes in the S&P 500 since the mid-1970s.

The green boxes mean gold rose during the market crash; yellow means gold fell but less than the S&P 500; and red means it fell more.

While stocks crashed, gold would preserve and even grow your wealth more often than not.

Why Gold Shines During Turbulent Times 

Gold's enduring appeal as a safe-haven asset is rooted in its unique characteristics.

First, it has maintained its value over centuries, providing a reliable hedge against inflation and currency fluctuations. Second, gold's price movements often diverge from those of stocks and bonds, offering crucial portfolio diversification. Lastly, its global acceptance ensures liquidity even when financial markets are in turmoil.

These attributes, combined with gold's historical resilience during market downturns, make it a compelling option for investors seeking to fortify their portfolios.

Protecting Your Portfolio with Gold 

For investors concerned about the October Effect or general market volatility, incorporating gold into a portfolio can be a prudent strategy.

• Diversification: Allocating a portion of your portfolio to gold can help mitigate overall risk. Financial advisors often recommend a 5-10% allocation to precious metals as part of a diversified investment strategy.
• Dollar-Cost-Averaging: Instead of trying to time the market, consider regularly investing in gold throughout the year. This approach is known as dollar-cost-averaging and can help smooth out price fluctuations and reduce the impact of short-term volatility.

During market crashes, many investors panic and make rash decisions. However, history often shows that the best course of action is to stay calm and maintain your long-term investment strategy. Gold's stability during market turmoil can provide the reassurance needed to avoid impulsive selling.

October Effect: More Myth than Reality 

While the October Effect may be more myth than reality, it serves as a reminder of the importance of portfolio protection and emotional discipline in investing. By understanding the psychological factors behind market volatility and considering gold as a safe-haven asset, investors can navigate uncertain times with greater confidence.

Remember, a well-balanced portfolio that includes gold can help you weather market storms, whether they come in October or any other month of the year. The key is to have a solid strategy in place before market turbulence hits. This way, when others are panicking, you can remain calm, knowing that your diversified portfolio, including gold, is designed to withstand market fluctuations.

In the end, successful investing is not about predicting every market move, but about being prepared for various scenarios. Gold's historical performance during market downturns makes it a valuable tool in this preparation, potentially providing stability when you need it most.

Best,

Brandon S.  
Editor, GoldSilver