The Witch of October Is Here: Remember Short-Term Pain = Long-Term Progress

The month of October strikes fear into the hearts of many Wall Street veterans, and for good reason. Over the past 123 years, 7 of the 10 worst days in US stock market history occurred during this seemingly haunted 31-day stretch.

But there is nothing supernatural in these October scares: they are the remains of the 19th -century agricultural financing cycle. During the 1800s, farmers harvested and shipped their crops to market in the fall, paying for the operation with large withdrawals from their local banks. These banks, in turn, withdrew funds from the largest banks and trusts in New York City to replenish their reserves, making Wall Street’s financial markets particularly vulnerable to panic. Even after the United States transitioned to an industrial economy and reestablished a central banking system in the early 1900s, memories of past Octobers seem to have conditioned investors to panic out of habit. In October 2022 it can be only the last rally.

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Costs of allocation of tactical assets of the wardrobe

Panic is the mortal enemy of long-term investors, especially in volatile markets, but that doesn’t mean we have to sit idly by for another October scare. At times like these, the observation of the late David Swensen in his classic Unconventional success it is worth remembering:

“Perhaps the most frequent variant of market timing comes not in the form of explicit bets for and against asset classes, but in the form of passive drift away from target allocations.”

Many investors ignore this council at the time when it is most valuable. Instead, they let their profits circulate in the raws and then freeze when the markets go down to the Baixista territory. This is precisely the insidious form of tactical asset allocation that Swensen refers to.

But history shows that this is never wise. For every savant who successfully navigates the treacherous macroeconomic currents, many more suffer financial ruin in the attempt. Failure to rebalance may not be disastrous, but it will almost certainly drag down long-term returns.

Dow Jones Industrial Average: 10 worst trading days:

date One day descent
October 19, 1987 -22.6%
October 28, 1929 -12.8%
October 29, 1929 -11.7%
December 18, 1899 -8.7%
March 14, 1907 -8.2%
October 26, 1987 -8%
October 15, 2008 -7.9%
October 18, 1937 -7.8%
December 1, 2008 -7.7%
October 8, 2008 -7.3%

So why is this tactical asset allocation so common among pension funds, foundations, endowments and other institutional investors? Because many are advised by non-discretionary investment consultants who have no authority to rebalance portfolios, they simply neglect to advise their clients to do so. But managers need to take the lead and make sure they follow rebalancing at times like these.

Book Covers in the History of Financial Markets: Reflections on the Past for Today's Investors

Short term pain and long term gain

In principles, Ray Dalio advises readers to seek painful feedback so they can confront their deficits and gain the insight needed to eliminate them. He often repeats the mantra: Pain + Reflection = Progress. Economic events follow a similar principle. Today’s economic pain will likely intensify in the coming months, but that doesn’t mean we suffer needlessly. The mistakes of the past must be corrected. High inflation has persisted for too long and the restoration of price stability is absolutely essential to ensure future economic prosperity. We learned this in the 1980s. We don’t need to relearn it in the 2020s. We need to break inflation, and while this will be painful, it will be worth it.

Today’s difficulties will be nothing. After the recession of 1981 and 1982 subsided, the US economy came back stronger. Fueled by extraordinary technological innovation, the country enjoyed two decades of economic prosperity.

The last two and a half years have had many financial scares. Maybe we’ll see more this October and in the coming months. But when it happens, we will breathe freely again. In the meantime, we must embrace our nerves, rebalance our portfolios, and trust that the pain we suffer now will be rewarded in the future.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: ©Getty Images/Đorđe Milutinović

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Mark J. Higgins, CFA, CFP

Mark J. Higgins, CFA, CFP is a seasoned investment advisor with over a dozen years of experience serving large institutional investors, including endowments, foundations, public pension plans and corporate operating reserves. He is also an avid financial historian and is publishing a book on the complete history of the American financial system in early 2023 with Greenleaf Book Group. Higgins received a Master of Business Administration from the Darden School of Business and graduated Phi Beta Kappa from Georgetown University with a Bachelor of Arts in English and Psychology. He is also a CFA holder and a CFP professional.

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