Buy in October and Get Yourself Sober: Economic Hangover After the Election?
by: Jeffrey A. Hirsch and J. Taylor Brown

The term October-phobia frequently has been used to describe the phenomenon of major market drops occurring during the month. It can often become a self-fulfilling prophecy, so stay on the lookout, and don’t get whipsawed if it happens.

We (at the Hirsch organization) consider October a “bear killer,” as it has turned the tide in 11 post-WWII bear markets: 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001 and 2002. The jinx-month label, with which investors are most familiar, is likely because of crashes in 1929, 1987, the 554-point drop on October 27, 1997, back-to-back massacres in 1978 and 1979 and Friday the 13th in 1989. But, in the last six years, October has also catapulted to the top of the monthly rankings on big rallies following summer declines.

October also historically marks the beginning of the best six months of the year. The old adage goes, “Sell in May and go away,” but the flip side of that is “Buy in October and get yourself sober.” Not too catchy, but not much rhymes with October. Poets and wits can submit suggestions at our website, www.stocktradersalmanac.com, which also provides additional information on the “Best Six Month’s Investment Strategy.” (Since 1950, a $10,000 investment in the Dow would have gained $482,060 from November 1 through April 30, overshadowing a $318 loss from May-October on a similar $10,000 investment.)

So, What’s the Deal With October Anyway?
Why is October such a volatile month on Wall Street? There are many opinions made by market historians and pundits. We have read treatises on the subject and polled colleagues and friends. The theories differ vastly and many make excellent points. However, in our opinion it doesn’t matter; it just happens again and again. It is akin to the Yankees beating the Red Sox. Sometimes it’s the pitching that makes the difference, and sometimes it’s the hitting. Regardless of the reason, it is just something you know is going to happen, so brace yourself for it. Instead of the curse of Babe Ruth, consider it the curse of Charles Dow.

So October is dynamic for better and worse. Much has been written about the crashes and the bottoms, but most important and often overlooked is the actual performance of October during election years and the correlation to the end result of the election. If you want to figure out who is going to win the presidential election, forget about foreign policy. You can throw domestic issues in the trashcan along with tax policy, space exploration and stem cell research. Energy policy and the environment? Useless. When it comes to winning elections, to quote political strategist James Carville, “It’s the economy, stupid.”

October: Election Handicapper
There is a litmus test that has predicted the winner and loser of every presidential election over the past 100 years. If the Dow has risen 3.3 percent or more in October, the incumbent party has never lost. If the Dow has dropped 0.5 percent or more, the incumbent party has never won. End of story (see Table 1).


click image for larger view

If the Dow is up even fractionally, the incumbent party has only lost four of 17 elections: 1920, 1960, 1968 and 2000. Three of the four instances (1920, 1960 and 2000) involved a situation when the incumbent party lost power after two successful terms by a popular president, and the fourth (1968), as explained below, was one of the most chaotic political years in human history.

Remember Back
1920: The Dow gained 2.4 percent in October, yet Warren Harding ousted the Democrats, beating James M. Cox by a healthy margin. With World War I over, for all intents and purposes the incumbent party’s popularity had faded, as is often the case after war. The treaty of Versailles was signed in January 1920, though the U.S. Senate refused to ratify the treaty until the middle of 1921.

Bottom line: Popularity during wartime often fades by the time the war ends, or seems to be ending, and the next Presidential election rolls around.

1960: The Dow was up a “whopping” 0.18 points good for a 0.04 percent gain when John F. Kennedy beat Nixon. The country was on pins and needles over the Cold War. A U.S. U2 was shot down in the USSR, Castro was becoming a major nuisance, and JFK charmed the heck out of the populace during the first presidential campaign of the television era.

Bottom line: Video killed the radio star with the five-o’clock shadow.

1968: The Dow jumped a solid 1.8 percent, yet Nixon ousted the Democrats by beating Humphrey after Lyndon B. Johnson decided not to run. The year kicked off with the Tet offensive, followed shortly by the assassinations of Martin Luther King and Robert Kennedy.

Bottom line: Between the social unrest and LBJ leaving the Democratic Party high and dry, the incumbent party had little chance in 1968.

2000: The Dow rose three percent, yet George Bush eked out a victory over Al Gore in an election that was disputed, delayed and ultimately decided by the Supreme Court 35 days after election day. It was the first time since 1888 in which a president took office after losing the popular vote.

Bottom line: Al Gore summed it up best at the Democratic National Convention: “You win some, you lose some. And then there’s that little-known third category.”

But, When the Dow Is Down…
Conversely, when the Dow was down at all, the incumbent party lost six of eight elections. The two exceptions were 1944 and 1964 when the Dow was down 0.1 percent and 0.3 percent, respectively.

1944: After a 0.1 percent decline in October, Franklin Roosevelt defeated Thomas Dewey to lock up his fourth straight victory less than four months after U.S. troops stormed the beaches at Normandy. Needless to say, it was not a shocker.

1964: The Dow shed 0.3 percent, but Lyndon Johnson beat Goldwater. LBJ had been in power less than a year, and the country was still mourning the assassination of JFK. The stock market was strong all year, and Johnson’s “Great Society” fueled the economic expansion.

Early Warning
Simply knowing who is going to win the election only days before the election is not good enough for savvy investors. After grouping the October performance into Octobers when the incumbent party wins and when they lose, an amazing pattern emerges (see Chart 1).


click image for larger view

The Dow generally will foretell the fate of the incumbent within the first week or so of October. Historically, if the incumbent is destined to win, the Dow has been up nearly one percent at the beginning of October compared to an average decline of over two percent in an incumbent’s losing scenario. The picture is even clearer as the month progresses. While the Dow tends to rise more than two percent if the incumbent is going to win, the Dow tends to stay down, foreshadowing an incumbent defeat.

From the middle of the month on, the Dow will push higher and higher in anticipation of an incumbent victory, with strength during the last week of the month. Historically, the reverse is true for the losing scenario in October with the Dow pushing lower and lower the second half of the month – generally bottoming out just before the last week. Then there tends to be a fairly strong rally at the end of the month whether the incumbent is going to win or lose, as by now the market senses the likely outcome.

Gridlock is Best
Who should Wall Street be rooting for? There are six possible scenarios on Capital Hill; Republican president with a Republican congress, Republican president with a Democratic congress, Republican president with a split congress, Democratic president with a Democratic congress, Democratic president with a Republican congress, and a Democratic president with a split congress. See Chart 2.


click image for larger view

First, looking at just the historical performance of the Dow under the Democratic and Republican presidents, we see a pattern that is contrary to popular belief. Under a Democrat, the Dow has performed much better than under a Republican. The Dow has historically returned 9.1 percent under the Democrats compared to just 6.0 percent under a Republican chief executive. The results are the opposite with a Republican congress, yielding an average ten-percent gain in the Dow compared to a 7.8-percent return when the Democrats have control of the Hill.

With total Republican control of Washington, the Dow has been up on average 9.3 percent. Democrats in power of the two branches have fared a bit worse with 8.4 percent gains. When power is split, with a Republican president and a Democratic congress, the Dow has not done very well, averaging only a 6.8-percent gain. The best scenario for all investors is a Democrat in the White House and Republican control of congress with average gains of 11.5 percent. The most of dire circumstance occurs with a Republican president and a split congress averaging a net loss of 1.2 percent. There has never been a Democratic president and a split congress.

In the final analysis, October is an incredible handicapper of who is going to triumph on Election Day, adding to yet a greater mystique and aura of October on Wall Street. As a reminder, our long time friend and collaborator Sam Stovall of Standard and Poor’s reminds all investors “Treat history as a guide, but not gospel.”