Didier Le Menestrel

Seasonal volatility

While Mark Twain(1) is well-known for his adventure stories, he is also known to stockbrokers for his famous saying “October is a particularly dangerous month to speculate on the stockmarket. But there are others: July, January, September, April, November, May, March, June, December, August and February.”

This tongue-in-cheek saying surely contributed to the bad reputation of an autumn month that is always feared by investors. However, contrary to pre-conceived ideas, October is actually a fairly positive month on the whole: over the past 40 years, the US flagship market, Standard & Poor’s 500, has posted an average increase of 1% during October.

While the end statistic is presentable, on a daily level, October remains a very volatile month. In addition to the damage caused in October 1987 and October 2008 with respective plunges on the S&P 500 of 21.8% and 16.9% (its worst two monthly performances over 40 years), recent memory cannot forget the excellent rally enjoyed in October 2011 with a performance of +10.8%. Note finally, that over the same 40 years, the best month on the stockmarket was October 1974, when growth stood at 16.3%. October is not a bad stockmarket month, it is simply an excessively volatile month.

October 2014 and the 2.3% gain by the S&P 500 will not stand out in future statistics. However, European investors clearly did not experience an October like the others. On this side of the Atlantic, the stockmarket story is not the same. The Stoxx Europe 600 (European stockmarket index equivalent to the US S&P) fell by 1.8% over the past month and is struggling to restore its peak levels of the year, contrary to its US peer.

But above all, October 2014 confirmed the tradition of seasonal volatility. This volatility was fed by the sudden change in investor expectations concerning the timeframe for a rates hike in the US. The first increase in rates initially planned for spring 2015 seems to have been postponed indefinitely in view of weak global growth and the low level of global inflation. As such, expectations were changed brutally with equally brutal consequences on the market.

To make matters worse, the roll-out of new financial rules aimed at de-risking retail banks’ balance sheets meant these banks were incapable of providing prices and liquidity to the markets in real-time. The lack of banks in one of their historical businesses of market-maker, their inability to provide liquidity to all investors, prompted unexpected and spectacular collateral effects: on 15 October, the yield on the 10-year Tnote plummeted to an extent never seen before (-40bp/-16.4%) before ending virtually unchanged. In Europe, the yield on the 10-year Italian government bond widened by almost 50bp (+20%) in two days!

Discussing the chaotic markets performance in October, Jean Laurent Bonnafé (CEO of BNP PARIBAS) stated(2)“Banking balance sheets, subjected to new rules, are no longer allowed to have so many inventories”. Meanwhile the ROYAL BANK OF SCOTLAND(3) estimated that according to its indicator, liquidity in the credit market, namely the ease of executing transactions in corporate bonds, had lost 70% since the crisis in 2008.

This drying up of liquidity, at the very moment when disintermediation of financing of major companies is becoming the rule, clearly explains the violent movements that upset financial stock markets over the past month.

In our low rates backdrop, these badly controlled mood swings have to be accepted. Whereas they clearly offer increased possibilities to buy risk assets on attractive terms, they nevertheless impose a significant psychological effort in order to accept more volatility for the same long-term performance.

 Didier Le Menestrel

(1) American writer (1835-1910)
(2) BFM Radio 31/10/14
(3) RBS – The credit liquidity trap 23/07/14