It is not that our seasonal strategy beat the indexes in spite of the bear markets, it beat them because of the bear markets. Without the market’s valuation reset in each bear market (and the unfavorable season), there could not have been a raging bull market to make outsized gains.
October is the time of year when articles begin to appear in the media about the seasonal pattern of the stock market. The never-say-sell crowd that denies the summer & fall months are weak will now tell us we are entering the strongest time of the year for the market. Others take a more balanced view of the market’s seasonal tendency and present its historical or academic support. Mark Hulbert, a columnist for MarketWatch falls into the latter category and compares the actual results of two seasonal market timers in his recent article Those who sold in May are looking to return to stock market.
Source: MarketWatch Mark Hulbert
Before we discuss his findings, we need to understand his method. His own publication, the Financial Digest, tracks the performance many newsletters. To the ire of many market timers, Mark’s methods do not always track their actual performance based on the securities and levels of exposure they recommend. One method of comparison Mark uses is he applies a general timing signal to the Wilshire 5000 that represents the total US stock market.
Unless a market timer is specific, Mark’s service attempts to determine when an analyst would be 100% in or out of the entire stock market. Of course, timing for the entire US stock market may be different from small cap stocks or whatever the timer is recommending. And most timers are not all or nothing investors so it is definitely not a perfect method for comparison, but it is better than having no comparison.
Luckily, it does work with seasonal strategies since they exit stocks completely during the unfavorable season for equities. Mark is correct that Sy Harding developed a better seasonal strategy than the simple Sell-in-May strategy (Halloween indicator). Sy Harding based his timing signals on the same index he recommended investing in – the Dow Jones Industrial Averages – and it provided descent timing for other large cap indexes to include the Wilshire 5000.
While I understand why Mark Hulbert uses his method of comparison, the one factor in his article that could be improved is the time frame. He started near the bottom of a bear market and ends near the top of the current bull so he is examining two bull markets and only one bear market. If he backed this timeframe up to 2000, he would capture two complete cycles. I did and you will see why based on the annualized returns.
I compare the 15-year results for four strategies from market tops for two complete market cycles starting on July 4th 2000 through July 4th 2015. I applied the strategies to the four indexes: The Dow Jones Industrial Averages (DIA ETF), the S&P 500 index (TSP C fund, VOO ETF), the DJ Completion Index which is the total US stock market minus the S&P 500 (TSP S fund, VXF ETF) and the Russell 2000 small cap index (IWM ETF).
The four strategies are 1) Buy and Hold, 2) Sell in May 3) Sy Harding’s Seasonal Timing Strategy using the DJIA for timing signals, 4) and our own seasonal strategy optimized for each index. Each strategy starts with $10,000 and adds no more contributions other than re-invested dividends. I start by providing the seasonal strategies performance with no investment income while out of stocks. This highlights the fact, on average, all of the stock market’s gains came in the favorable season even if one only followed the simple Sell-in-May strategy.
If you compare the results in my table with Mark’s you will see the effects of the 2000 – 2002 bear market. You will notice the buy & hold strategy takes a much larger hit than Sy Harding’s strategy. Sy Harding’s annualized returns easily beat the indexes while only being invested on 52% of the time. The low-risk returns the other 48% of the time padded these numbers and we find he beat the Dow index by 3.62% annualized.
To put this into dollars, if you followed Sy Harding’s seasonal timing you gained $29,068 over the original 10K compared to $13,000 for a buy and hold investor. A bump of 3.62% annualized more than doubled your gains in 15 years. But here’s the kicker, Sy’s strategy was not fully optimized.
Years ago when I first researched Sy Harding’s results I was surprised to find that he used the default setting on the MACD indicator he had incorporated into his strategy. By simply optimizing the MACD as recommended by its developer I was able to improve upon his results during back-testing. After more research I found several other improvements.
Sy Harding was the first to put forth an advanced seasonal strategy to be tracked along side his own award winning technical analysis. But if you dig into Mark Hulbert’s investment newsletter tracker, you find Sy’s mechanical seasonal strategy beat his own impressive subjective analysis over the long run. Very few financial newsletters have been able to beat the indexes over the long run and here we have a simple strategy that has whether looking back 10-years or 60-years.
In the table, you see the results of our optimized seasonal strategy. Each index generates its own timing signal using a slightly different formula for large and small cap funds. The smaller capitalized indexes saw the largest improvement and best overall results for seasonal investing. If you merely held the Dow Jones Total US Stock Market Completion Index (small & mid cap fund – TSP S fund or VXF ETF) you gained $14,951 in 15 years, but if you followed an optimized strategy your funds gained $56,144 during this time!
It is not that our seasonal strategy beat the indexes in spite of the bear markets, it beat them because of the bear markets. Without the market’s valuation reset in each bear market (and the unfavorable season), there could not have been a raging bull market to make outsized gains.
The seasonal strategies take advantage of the fact that the bulk of market losses occur during the unfavorable season for equities and the advanced strategies are able to take advantage of the market trend at entry and exit points. Since the small cap funds observe the largest gains during bull markets and the favorable season, and largest losses during bear markets and the unfavorable season they benefit more than large caps from seasonal investing.
The best way to compare performance of any strategy is over the full market cycle (bull and bear market) not by 3-year or 5-year returns which may only capture a bull market. Many funds and timers who lead during the bull markets get crushed during bear markets. You need a strategy or advisor that navigates both markets well. Our service uses a seasonal strategy not because we originally invented it, but because our extensive research found it was the best core strategy for investing in large low cost index funds.
When it comes to mitigating market risk, our opinion is you should focus on three primary factors: 1) allocate based on your age or years to retirement 2) avoid the unfavorable season for equities 3) reduce exposure to stocks when indications of bear markets and large corrections are elevated regardless of the season. Unlike most strategies, ours increases your long term returns by lowering your risk, not by raising it. In our opinion this is what makes a “smart investor”.
TSP & Vanguard Smart Investor provides a simple-to-follow low cost timing service for any investor not just the government Thrift Savings Plan (TSP) or Vanguard accounts. Choose the level of service that fits your needs to make more informed allocation decisions. Our goal is to help you avoid absorbing wall street’s losses and secure a better retirement. Invest smart.
Categories: Seasonal Analysis, Seasonal Perspectives, Vanguard Smart