If stocks see another big swoon this year, investors already know why

October's fearsome reputation is somewhat overblown. But there are still risks worth watching this year.

October has a fearsome reputation for stock-market tumult, largely due to a handful of notoriously grim selloffs. Yet a look at market returns over the past century suggests that those fears may be somewhat overblown.

"The month has a somewhat undeserved reputation as a tough one for stocks for much the same reason the otherwise commonplace words 'titanic' and 'iceberg' are inextricably linked," said Wall Street veteran Nicholas Colas, co-founder of DataTrek Research, in commentary shared with MarketWatch on Friday.

An analysis from Dow Jones Market Data bears this out. Since 1928, the S&P 500 SPX has averaged half-a-percentage-point gain in October, with a 58% win rate. That average return places it firmly in the bottom half for monthly performance - but not at the bottom. February and September are the only two months with a negative average return.

 
 Month                           S&P 500 
Jan    1.2% 
Feb    -0.1% 
Mar    0.5% 
Apr    1.4% 
May    0.1% 
June   0.8% 
July   1.7% 
Aug    0.7% 
Sept   -1.1% 
Oct    0.5% 
Nov    1.0% 
Dec    1.3% 
       Source: Dow Jones Market Data. Based on data back to 1928 

The crashes of October 1929 and 1987 were particularly memorable. October 2008 was bad too, as stocks sank during the most acute phase of a historic global financial crisis. To that list, Colas added a few more examples.

They include October 1990, when stocks bottomed following the Iraqi invasion of Kuwait; October 1997, when the Asian financial crisis sent global markets into a tailspin; October 2002, when the S&P 500 finally bottomed out after a long, painful post-dot-com bear market; October 2011, when the Greek debt crisis rattled investor confidence in emerging and developed markets; and October 2022, when the S&P 500 put in its most recent bear-market low.

What to watch

What will become of October 2026 remains to be seen. Yet there are some pretty serious risks worth monitoring this year. If stocks do hit the rocks, investors at least have a good idea of what might cause it.

According to Colas, rising Treasury yields created problems for much of the U.S. market in September, even as a handful of hot stocks tied to the artificial-intelligence trade helped to offset a lot of these losses at the index level. The idea that hot tech stocks are immune to the pressures of rising interest rates helped make the tech sector the only gainer in the S&P 500 last month. Yet Colas believes this hollowing-out has left the market in a fragile state. Enormous expected earnings growth has helped to shield AI stocks so far. But the trade can only resist the pull of rising rates for so long, Colas said.

To be sure, there is at least one important caveat worth considering when taking historical performance into account. A Dow Jones Market Data analysis found that during midterm-election years, the month leading up to Election Day has been a notably strong period for equity returns. The S&P 500 has averaged a gain of 3.9% overall since 1950, data showed.

Friday's strong showing for stocks has helped to revive some of investors' flagging optimism, hinting at further gains ahead in the fourth quarter, said Jose Torres, senior economist at Interactive Brokers. Treasury yields declined early on Friday, helping to usher in a broad-based rally for stocks. The move in yields had reversed by the time the closing bell rang. And yet, major equity indexes still finished broadly higher on the day.

"Friday showed us that when yields go down, equities should soar," Torres told MarketWatch.

Another reason to be optimistic: The fourth quarter has consistently delivered the strongest returns of any calendar quarter, Dow Jones Market Data showed.

 
   Month           S&P 500 record finishes 
January    132 
February   122 
March      122 
April      116 
May        117 
June       109 
July       156 
August     105 
September  98 
October    112 
November   174 
December   113 
           Source: Dow Jones Market Data, FactSet 

In fact, November has seen the most record closing highs for the S&P 500 of any month.

What to do

If stocks do hit the rocks, Colas has a playbook that has worked in the past. When stocks are selling off, he looks to the Cboe Volatility Index VIX, Wall Street's unofficial "fear gauge," for guidance on when to swoop in to buy the dip.

A VIX reading of 27 is one standard deviation above its long-term average of 19.4. The one-month win rate for the S&P 500 following readings of between 27 and 43 on the VIX is 70%, Colas said.

Despite weakness beneath the surface in the market, the VIX has been pretty tame recently. It finished Friday at around 15.5, FactSet data showed.

The odds currently favor the Federal Reserve holding steady for October, but hiking rates in December. Any pause in the fresh Fed hiking cycle could increase appetite for stocks.

There are still a slew of Fed speakers on tap for the week ahead that could influence a jittery bond market, as well as minutes of September's central-bank meeting, due on Wednesday.

Last week, the Nasdaq Composite COMP gained 0.5%, ending at 27,190.86, only 0.2% below its September record close, according to Dow Jones Market Data. The S&P 500 fell 0.3% for the week to 7,722.72 and the Dow Jones Industrial Average DJIA lost 1.3%, ending the week at 51,176.96

-Joseph Adinolfi