Surprisingly, seasonal investing strategies are one of the most simple, safe, and historically proven strategies. They also have academic support. The most effective seasonal strategies are more advanced than Sell-In-May. They are also perfect for tax deferred accounts that allow allocations in index funds. Two allocation changes a year can significantly increase long-term returns and while reducing risk of market losses. Since being out of the market half the year would hurt fee income, seasonal strategies are not popular with mutual funds and commissioned based financial advisors. I enjoy taking a look at the real numbers behind seasonal myths and strategies to see if they hold water or can be improved. But first let’s consider the theory.
In their book “The January Effect and Other Seasonal Anomalies: A Common Theoretical Framework” authors Anthony Cataldo from Western Michigan University’s Department of Accountancy and Arline Savage from the School of Business Administration at Oakland University pervasively argue that “these seasonal stock price patterns are statistically significant” and is congruent with John Maynard Keynes’ Theory of Liquidity Preferences. They reference over 100 academic articles and books on the subject that prove the existence of seasonal stock market patterns. They are the first to show seasonal patterns fit within a theoretical structure and Keyes’ seminal work “The General Theory of Employment, Interest and Money” provides the framework.
So what causes the seasonal stock price patterns? While investors are not dumb, the flow of their investments can be. Automatic payroll retirement account deductions and automatic dividend reinvestment flowing into the market tends to provide more price support during those days. End-of-Season “window dressing” by fund managers, tax-loss selling then buying back in the New Year, as well as paying quarterly taxes all affects the flow of funds into and out of the market and creates date-specific variances in prices. I have found that NOT every month or year has the same seasonals, so carefully analyzing historic daily movements in different market climates is necessary to fully understand the dynamics.
Most academic studies tend to keep it simple and include every year and every month when looking for anomalies. These one variable studies find them, but by taking into account a few additional variables I have found greater variances that become tradable. It is important to understand that if historically a two day period shows an average 1% return, it will vary greatly on any given year. In other words, if the market is flat on those days this year, the variance still exists but without the 1% positive seasonal support the market probably would have been down 1% that day and the market is showing weakness. This weakness may manifest itself on the next few trading days as the seasonally positive support is removed. Understanding daily seasonal variances can make for better trading, but how about long-term investors?
Seasonal timing strategies with only two allocation changes a year have been shown to greatly reduce risk and increase long-term returns. You might ask, don’t you have to increase risk to increase returns. The answer is no if you consider how seasonal investing works. Again, you will not hear this from the investment world that wants you always in or moving your money around to increase fees and commissions. They will also provide you over 50 measures of risk, 200 technical analysis tools on over 100 trading software programs all designed to “help” you trade. The only risk that matters is your risk of significant losses. You can never eliminate small losses due the daily or weekly ebb and flow of the market, but you can reduce the number of times your portfolio takes a 10% hit or an all-out bear market hit of 30-40% simply by avoiding the timeframe these events have historically happened. Researcher, Nelson Freeburg in Formula Research (August 21, 2001) showed that for 31 of 34 declines of 10 percent or more in the DJIA, “the brunt of the sell offs occurred during May – October.” Obviously, avoiding these losses is the primary reason seasonal strategies beat the Buy-And-Hold strategy over the long run. The concept is very simple and I will be discussing the timing and performance in later articles.
Written and edited by Michael H Bond for Almanac Smart
Categories: Seasonal Perspectives