Being Street Smart
Seasonality Revisited
by Sy Harding
As I've pointed out
in the past, the stock market has a powerful tendency to make
most of its gains between November and April, and to suffer most
of its declines in the opposite season of May to October. The
pattern is so consistent that an investor who bought the S&P
500 in late October and switched to cash in early May, repeating
the process each year, would have almost doubled the total return
of the S&P 500 over the last 35 years. (The results are based
on making the switches each year in an IRA or 401K where taxes
on the profits would not be a factor).
Just as significant
as the gains, following such a strategy would have cut investment
risk in half since the investor is only in the market six months
out of every twelve.
Why would the stock
market have such a consistent pattern?
Investors receive large chunks of extra money each year between
November to May, and much of that extra money finds its way into
the stock market, driving stock prices higher. The extra money
comes from capital gains distributions from mutual funds, which
begin in November each year, Christmas bonuses, year-end bonuses,
employers' annual contributions to their employee's 401K plans,
income-tax refunds, etc.
However, by April those
chunks of extra cash dry up, depriving the market of the extra
fuel that was driving stock prices higher. As trading volume
dries up the market enters what is traditionally known as its
'summer doldrums'. Buying activity no longer dominates, leaving
the market vulnerable to any selling pressures that come in as
a result of unexpected events, poor earnings, disappointing economic
news, or whatever.
The strong seasonal
pattern is a very useful investing tool. We use it, in conjunction
with short-term momentum reversal indicators (which better pinpoint
the entries and exits than a simple calendar approach) as the
basis for our Seasonal Timing Strategy. This year's Stock
Trader's Almanac dedicates a full page to a report on our
seasonal strategy. Back-tested over the last 35 years it tripled
the total return of the S&P 500, while eliminating 50% of
market risk by only being invested an average of six months a
year. Interestingly, the folks at the Stock Trader's Almanac
went a step further, back-testing what would have happened if
an investor had invested opposite to the strategy, that is entering
the market for the unfavorable summer seasons and remaining in
cash during the favorable winter seasons, reporting that following
that strategy would have resulted in an actual loss over the
long-term.
That's pretty good
reason to believe that any problems the market is having during
its summer doldrums this year are likely to also be seasonal,
with a good buying opportunity coming up in the fall. Based on
the momentum reversal indicators we use, the next favorable season
could begin as early as the first week of October or as late
as the end of November.
Editor's Note: Sy Harding is president of Asset Management Research Corp., 169 Daniel Webster Hwy., Meredith, NH 03253, publisher of The Street Smart Report, 1 year, 17 issues, $225 (now in its 13th year of exceptional market research for professionals and serious investors) and The Street Smart Report Online at www.StreetSmartReport.com. Mr. Harding has been consistently ranked in the Top Ten Timers for years. He authored the book, Riding the BearHow to Prosper in the Coming Bear Market, $12.95. In Riding The Bear, Mr. Harding reveals that while many Wall Street pros urge investors to hold steady during market declines, these same Wall Street pros and institutions sell quickly at the first sign of a market turning. He explains in plain English how the market reacts, how cycles work, and how to take advantage of them to hold onto your bull market profits and actually increase them during a bear market. Available at most book stores, amazon.com, barnesandnoble.com or StreetSmartReport.com.
