Small-cap and value stocks hate October

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By Mark Hulbert, MarketWatch

CHAPEL HILL, N.C. (MarketWatch) — Does October deserve its reputation as being a bad one for the stock market?

It depends on what you invest in.

As far as the overall stock market is concerned, however, there is no seasonally-based reason to stay in cash in October. Even though many consider the month to be a terrible one for stocks, no doubt because the two worst crashes in U.S. history took place in October, the month’s average return is—within statistical tolerances—no different than that of all other months in the calendar.

But, for certain sectors of the market, October does deserve its bad rap.

Consider small-cap stocks. In all months besides October since 1926, according to data compiled by finance professors Eugene Fama and Ken French (of the University of Chicago and Dartmouth), the typical small cap has outperformed the typical large cap by an average of 0.34% per month.

In October, in contrast, they have lagged the large caps by an average of 0.85%.

That difference of 1.2 percentage points per month — more than 12% per year on an annualized basis — is significant at the 95% confidence level that statisticians often use to determine if a pattern is genuine.

Another stark seasonal pattern concerns value stocks — those that have relatively low price-to-book ratios. In all months besides October, such issues have beaten the typical growth stock by an average of 0.45%. In October, in contrast, they have lagged by 0.35%.

Once again, this difference is statistically quite significant.

What these results mean: Assuming this coming October lives up to this historical pattern, you should bet on large-cap growth stocks over small-cap value stocks.

One way of betting on these historical tendencies would be to purchase exchange-traded funds that are benchmarked to these styles. Two ETFs that you could consider in this regard are the SPDR S&P 500 Growth fund and the Vanguard S&P 500 Growth fund.

By the way, you can bet on these historical tendencies without making a bet on the direction of the overall market. A market-neutral way to do so would be to sell short the same dollar amount of small-cap value ETFs as you have invested in large-cap growth ETFs. Two that would fit in this category of ETFs that you would short are the iShares Russell 2000 Value ETF and the Vanguard Russell 2000 Value ETF.

Do any of the other asset classes exhibit any October-related seasonal tendencies? One that does not is the bond market. That at least is the conclusion I drew upon analyzing the historical database maintained by the American Association of Individual Investors, which contains bond market data back to the 1940s.

Gold, however, is a different story: Since 1980, as I reported in a recent column, bullion has been a below-average performer during October. ( Read my Sept. 28 column on gold’s historical tendencies during October .)

The bottom line? So long as you tiptoe carefully, there’s no reason to stay in cash this coming month.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.

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