Will October live up to its reputation as a bear market killer?

If September is the worst month for stock markets historically, October is the most volatile and unpredictable.

It has hosted two of the biggest crashes in history, the Wall Street crash of 1929 and Black Monday in October 1987.

Many investors see it as a month of doom, but it has a second, lesser known reputation.

October is also known as the “bear market killer”, with six of the 17 bear markets since the Second World War ending during this month.

It looks set to be volatile and unpredictable this year, after the S&P 500 fell 4.87 per cent in September, calling a halt to what had been a stellar year up to then.

With the 36th anniversary of Black Monday looming on October 19, many analysts are wondering whether we are heading for another shock.

The difference is that Black Monday came out of the blue, while today a rash of analysts are jumping up and down warning of the dangers. How worried should we be?

Nobody quite knows what caused Black Monday, but as ever, there are theories.

After a five-year bull run, markets were considered overvalued. The US was posting regular trade and budget deficits, interest rates were rising.

Sounds familiar?

All those factors are in play today. Despite the recent dip, US shares look pricey trading at 24.6 times earnings, well above their mean of 16.03 times.

The US has been posting a trade deficit since 1976 and budget deficits are a given. The country's debt flew effortlessly past the $3 trillion mark last month with zero sign of slowing down.

It’s now so significant Washington has stopped worrying about it, and was baffled when Fitch recently downgraded its credit rating from AAA to AA+.

In another echo with 1987, interest rates are rising today, and at speed. Markets thought the worst was over until the US Federal Reserve's “hawkish hold” in September when chair Jerome Powell suggested there is more pain to come as the country’s economy refuses to cool despite rates hitting 5.5 per cent.

Investors who spent this year waiting for interest rates to start falling now accept it may not even happen in 2024.

That’s bad news for the bond market, as fixed-interest investments look less attractive when rates are rising generally, and prices have collapsed while yields have soared.

The only thing that can save the bond market is a stock market crash, according to Barclays analysts led by Ajay Rajadhyaksha. September’s 5 per cent dip was nowhere near big enough.

Investors are only now accepting that the era of zero interest rates and free money is well and truly over, says Russ Mould, investment director at AJ Bell.

“The higher yields go, the less inclined investors will be to pay extra for risk assets like equities,” he adds.

With 10-year US Treasuries now yielding 4.8 per cent and expected to go higher, that spells trouble for shares.

“Bond yields are now the highest since summer 2007, just before the Great Financial Crisis hit home,” Mr Mould says.

The rising cost of money will also hit real activity in the real economy, squeezing corporate earnings, he adds.

For the past two decades, whenever stock markets wobbled, central bankers restored order by slashing interest rates, but they cannot do that today as they battle to get inflation back to their 2 per cent target.

Mr Mould says the past 15 years of ultra-cheap money have been an aberration for share prices, cryptocurrencies, non-fungible tokens and other asset classes, too.

“The party has been huge. Perhaps the hangover is now on its way,” he warns.

With the US teetering on this session, September’s sell-off could only be the start. Plenty of people think so.

Albert Edwards, a global strategist at French investment bank Société Générale, has warned that markets are mimicking the run-up to Black Monday.

“All you can do is brace yourself and hope for the best,” he advises.

It should be noted that Mr Edwards is a renowned “permabear”, who has been spreading gloom since the 1990s.

Today, though, he’s far from alone. JP Morgan’s chief market strategist Marko Kolanovic warned of a potential 20 per cent downside, with the Magnificent Seven tech stocks Amazon, Alphabet, Alphabet, Meta, Microsoft, Nvidia and Tesla particularly hard-hit by a recession.

Yet, others are more optimistic. Ed Yardeni, the founder of Yardeni Research, is still calling a 2023 Santa Claus rally that would lift the S&P 500 to somewhere near 4,600 points, some 7 per cent higher than Monday’s opening level of 4,308.50.

Any sell-off in the weeks ahead could be an opportunity for investors who feel they have missed out on this year’s artificial intelligence-fuelled US tech stock rally, says Vijay Valecha, chief investment officer at Century Financial.

“Today’s volatility could present a chance to invest early before prices potentially surge in the last months of the year, a pattern that often repeats itself,” he suggests.

History shows that after a poor September, the S&P 500 generally picks up in October and November, and rallies until April, he says.

“There are signs that US inflation is easing and recession fears have also been overdone, indicating a soft landing.”

As ever, there are no guarantees, but investors who are convinced could take advantage of any further dips to buy a low-cost exchange-traded fund tracking the index, such as the SPDR S&P 500 ETF Trust, iShares Core S&P 500 ETF or Vanguard 500 Index Fund, Mr Valecha says.

Really brave investors could target US tech stocks through a fund like Global X Robotics & Artificial Intelligence ETF and Ark Innovation ETF, he adds, but cautions: “They may still be overvalued, notably chip maker Nvidia, which is up 292 per cent in the last 12 months and 642 per cent over five years.”

Mr Valecha says now could even be the time to take advantage of the bond slump and buy US Treasuries.

“As yields reach all-time highs, bond prices have slumped to levels never seen before, resulting in an opportunity to buy the bonds at a lower price to grab high yields and potential capital gains when prices recover,” he adds.

The iShares US Treasury Bond ETF, Vanguard Short-Term Treasury and SPDR Portfolio Long Term Treasury ETF are options here.

Buying shares when markets crash is risky, though. Just as nobody can say whether shares will fall, nobody knows when the recovery will come, either. October will decide. It often does.