Why do Stocks crash in October?

It is a funny fact of history that stocks seem to crash (20% drop in a few days) in October as opposed to any other month. The only theory which seems to explain this with any real validity involves agricultural cycles and liquidity problems for New York banks. After the Civil War, a federal law was passed that required country and agricultural banks to keep 25% of their deposits with certified national banks which were mainly based in New York. Because the New York banks had to pay interest on these deposits which could be recalled at any time, they lent this money to the Wall Street brokerage houses which in turn lent it to speculators for margin loans. In theory. this made sense to the national banks because call rates were high, and if any of their deposits were recalled, they could quickly get their money back on a daily basis as long as liquidity was good.

So to a certain extent, stock market liquidity was dependent on how much agricultural banks had on deposit with the major New York banks. This, of course, was dependent on the agricultural cycle and particularly the wheat harvest. When the harvest was complete and ready to be shipped East, the agricultural and country banks would recall their deposits with the New York banks which would recall their margin loans. As a result, money became very tight on Wall Street, and margin rates soared (reaching at times 1% per day).The worst of the liquidity crunch was in, which would be the reason that speculators on margin were forced to sell their shares to meet margin calls. This would create a cascade effect if there was a enough leverage in the system.

While this theory explains market crashes in the late 19th and perhaps early 20th centuries, it still does not explain why we still have crashes in October like 1987 and 2008. The only idea I have is that by now every market participant and investor has developed a deep psychological fear of October (because of previous crashes), which leads to a self-fulfilling prophesy. Finally, I will leave you with a quote from Mark Twain who wrote, "October.this is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February."

Black Swan Insights