Protecting Your S&P 500 and Small Cap Index Funds in a Bear Market

If we look at the price progression of the last two major bear markets, we find most of the losses took place during the seasonally weak season for equities.  Following the simplest seasonal strategy, Sell-in-May, would have avoided 75% of the S&P 500 drawdown in both the 2000 and 2007 bear markets.

Below we look at the period of 1 Nov 2000 through 31 Oct 2002 and the period from 1 Nov 2007 through 31 October 2008.  Remember, the point of this examination is to focus on the drawdown and not the full cycle performance.

Let’s start with the S&P 500. During the first bear market, the seasonally strong period produced an 11% loss and the seasonally weak period produced a 33% loss or 75% of the S&P 500 index’s total loss during this period.

11/1/2000 1429.4 5/1/2001 1249.46 -12.59%
11/1/2001 1059.78 5/1/2002 1076.92 1.62%
5/1/2001 1249.46 11/1/2001 1059.78 -15.18%
5/1/2002 1076.92 10/31/2002 885.76 -17.75%

Repeating the performance in 2007, we see again 75% of the S&P 500 losses were in the seasonally weak period.

11/1/2007 1545.79 5/1/2008 1385.97% -10.34%
5/1/2008 1385.97 10/31/2008 968.75 -30.10%

Now let’s take a look at the Russell 2000 index representing small cap equity funds.   Practically all of the losses were in the seasonally weak period, with cumulative gains in the seasonally strong period during the 2000 – 2002 bear market.

11/1/2000 497.68 5/1/2001 485.31 -2.49%
11/1/2001 428.17 5/1/2002 510.67 19.27%
Date Price Ex. date Ex. Price % chg
5/1/2001 485.31 11/1/2001 428.17 -11.77%
5/1/2002 510.67 10/31/2002 373.5 -26.86%

But the rapid 2007 bear market did see losses during the seasonally strong period, but as we see one third of the losses were in the strong six months, while two thirds were in the weak 6 months.

11/1/2007 822.88 5/1/2008 715.54 -13.04%
5/1/2008 715.54 10/31/2008 537.52 -24.88%

Seasonally hedging your investments would have reduced your losses during the last two bear markets.  One should consider reducing exposure during the seasonally weak periods for equities, especially when the current bull market is long in tooth, and sentiment is over-bullish, and when a their has been a lack of a correction in two years.

You can improve upon this simple strategy by following more advanced seasonal strategies that refine the start/stop dates for the strong/weak periods and then use a trend following technical indicator to delay action, if favorable, for entry and exists.  This allows you to create more of a window for entry or exist of the market and can significantly improve results over the already favorable results noted above.  Simply put, adding a seasonal filter to your exposure levels will increase not only your risk adjusted returns, but also your non-risk adjusted full market cycle returns.  Invest smart.  Almanac Smart.

Categories: Seasonal Perspectives

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