What Happened to the October Crash?

What happened to the fall correction?

As the summer ended, investors heard many voices warning that the market’s gains weren’t sustainable and that we could be headed for another October crash. Instead, the Dow hit 10,000 on Oct. 14. Of course, the month isn’t over yet and another selloff is always a possibility, but if the gains hold, they’ll debunk a lot of naysayers.

The pessimists included many SmartMoney readers: When we polled visitors on Oct. 6, a minority – 38% – said they expected the Dow to hit 10,000 before Dec. 7, which was the average forecast of a SmartMoney survey of financial pros. Why were so many so pessimistic about October?

One reason is a surprisingly rosy start to the third-quarter earnings season. Historically, October is a month for losses, but many companies are reporting better-than-expected results, lifting broad market sentiment. “These incredibly strong earnings reports are just defying gravity,” says Tommy Williams, the president of Shreveport, La.-based Williams Financial Advisors. In August, Williams says he expected a fall pullback in part because of profit-taking, but “right now it doesn’t look like that’s going to happen,” he says.

Momentum is another factor. Many investors are scrambling to get in on the rally and giving the market an added boost, says Roy Williams, the chief executive of Prestige Wealth Management, an investment firm based in Pennington, N.J. (Roy Williams is not related to Tommy Williams.) Investors who pulled their money out of the market early in the year started jumping back into the market in September, Williams says. “They’re afraid to miss [the rally], but they already missed it,” he says.

Whether the rally is at an end or has more steam, crossing the psychologically important 10,000 mark may have helped reassure some nervous investors. “Just the fact that the Dow hit 10,000, I think, made people wonder, ‘Maybe this is for real,’” Tommy Williams says.

Perhaps investors are acting on psychology and momentum because recent economic data haven't provided much direction. Housing starts for September rose a weaker-than-expected 0.5%, and the August increase was revised downward. And for all the positive earnings data, unemployment remains high. “We’re kind of muddling through, absent any significant news on the upside or the downside,” says Kevin Mahn, managing director of Hennion & Walsh. As a result, a sharp pullback in the market may have been replaced by a series of “pauses,” Mahn says.

Some investment professionals caution that a correction still could be on the way. “A lot of these earnings beats are coming on the back of very significant cost cutting, and not due to any sort of rebound in demand or revenue,” says Paul Larson, an equity strategist at Morningstar. Cutting costs often means cutting jobs, and consumers without jobs can’t spend much. “I would not be surprised if we saw [a correction] at some point,” Larson says. As for when: “I have zero idea regarding the timing of what the stock market’s going to do in any short period of time,” he says.

For some investors, the fall pullback that didn’t happen was a reminder of the market’s one certainty: unpredictability. “The stock market is a funny place,” Larson says, “and usually when everyone expects something to happen, the opposite tends to happen.”