Stocks rise and fall based on a company’s performance and profitability, right? Well, not necessarily. Upon reading Roger Martin’s, Fixing the Game, one begins to understand that while profits and performance can lead to improvements in a company’s stock price, it is not the end-all-be-all. Instead, the volatility in the stock market has much more to do with perceptions and expectations.
When a company is ready to announce their quarterly results, it can seem like the entire investment world stops in anticipation. Market analysts have made their best estimates as to how they believe the company has done or should have done, and then those numbers are pinned up against the company’s actual numbers when they give their press release.
When the information is made public, a stock tends to rise and fall based on how well the company did vs. the expectations in the short run. For example, if a company earned $100 million in profits that quarter, but analysts assumed they would earn $120 million, the stock could tumble after the final earnings are announced. Investors pay up in terms of higher valuation multiples for strong growth and rising expectations. When expectations disappoint, stocks can get punished until management proves themselves worthy again over the next several quarters.
SEASONAL TRENDS AND INVESTING STRATEGIES
The stock market has historically been a place of great fortune for those who’ve chosen stocks well and held over the long term and great disappointment for others. Investors are constantly looking for the next breakthrough analysis that can give them deeper insights into the market and allow them to earn more money with the least amount of risk possible.
Amongst the many studies and research analysis are seasonal trends: months that have historically seen profits in repeat years, and other time-frames that have often seen recurring losses. Based on these trends, some investors, using qualitative research, alter their timing of buys and sells and believe that by following seasonal trends they can earn more in the market.
1) Sector Rotation Strategy
The sector rotation strategy is not necessarily a theory based on seasons, but it has everything to do with timing the strengths and weaknesses of the market. In its most basic form, this strategy tracks the momentum of large sectors of the stock market such as Financial Services, Energy, and Technology.
When certain sectors are performing well, investors who apply sector rotation strategy typically buy stocks in those well-performing sectors and ride the momentum until a signal shift tells them otherwise. When tracing this strategy back to the 1920s, studies have shown that a momentum based strategy has outperformed the buy-and-hold strategy approximately 70% of the time.1 One reason investors may choose to apply sector rotation strategy is to diversify their holdings over a certain period of time. There are many different sectors in the economy so naturally they don’t all rise and fall simultaneously.
Thus, one can buy into a sector as it is rising and then use the sale proceeds as the sector downshifts in order to buy into and gain exposure in a different sector that is on the rise. This can enable investors to rotate in and out of sectors over time to take advantage of changes in business and economic cycles. The key here is timing and knowing when it’s time to sell out of one sector and buy into another sector. Trading sector-based ETFs are one way to easily increase or decrease your exposure to large segments of the market.2
2) Sell in May And Go Away. But Don’t Forget To Come Back In September
There is a popular saying in investing that goes “sell in May and go away.” Some investors stick with the idea that gains are typically earned more often between the months of November through April and that the other six months of May through October tend to underperform and yield very little, hence the expression.
When viewing the returns of the Dow from the 1950s, one can begin to understand why this phrase has stuck with some investors for so long. The months of November to April have yielded an average gain of 7.5% while the months of May to October have earned just 0.3%. Less trading volume over the summer months when people tend to travel for vacations and more investment flows in winter are two possible explanations for this recurring pattern.3
Historically, September has commonly been an underperforming month compared to the rest of the year.4 So the trading expression, “don’t forget to come back in September” is a strategy that investors can consider if they have money they want to put to work. If prices have dropped in September and one anticipates a rise in the coming months, it can be a signal for these strategists to buy.
3) Santa Claus Rally
Another common seasonal trend in the markets that you may have heard of is known as the Santa Claus rally. Put simply, this theory revolves around the thought that some stocks have historically risen during the days in between Christmas and the first couple trading days after New Year’s. The average cumulative return over these few days is 1.6%. No one can seem to pinpoint an exact reason for this, but some speculate it could be due to5:
- Year-end tax related portfolio adjustments
- Optimism during the holiday season
- Short-sellers being on vacation
The list may seem a little strange, but the positive gains are something to smile about.
4) The January Barometer And January Effect
There’s an investment phrase that says, “As goes January, so goes the year,” stemming from the idea that the performance of the S&P 500 in January can indicate how the rest of the year could turn out. While this “January barometer” was true about 75% of the time between 1950 and 1984, the patterns in years since 1985 haven’t held up that well. As a result, even though you may hear the expression still used today, it isn’t a very reliable theory to use when making investment decisions.6 For example in January 2014, the S&P was down 3.6%, but climbed over 15% between February and December.7
On the other hand, the “January effect” is a different market hypothesis that speculates stock prices, primarily small cap stocks, have a tendency to increase the most in the month of January, more than any other month. This seasonal trend could influence investors to buy shares before January starts and sell shares by the end of the month.
The markets have adjusted and fewer people are actively selling at the end of December for the purpose of claiming losses on their tax returns, which previously spurred increases in buying during the month of January.8
WHICH TYPES OF STOCKS SHOW SEASONALITY?
Some stocks have shown more seasonality than others. Research has shown upon viewing many years of data for these same stocks, that certain months have been historically more profitable than others.
Seasonal trends have been seen in many industries including banking, retail, oil, and even health care. Banking has historically been strong from October through May. Retail has shown strength between September and June. And the oil sector has often experienced an uptick in December.9 If you are looking for seasonal trends in specific industries, you can utilize historical data to help you make your own trading decisions. Since the markets can be unpredictable, however, there is always a risk that such historical seasonal trends amongst certain industries may not continue.
IS IT WISE TO INVEST BASED ON SEASONAL TRENDS?
While there have been observed trends across many sectors in the market, and some fodder for market commentators to discuss, there is no guarantee that those trends could continue in the years to come. For this reason, choosing to invest based on a point-in-time on the calendar and historical patterns may not fall within your risk levels or provide a solid foundation to validate your investment strategy. For example, the past Santa Claus rallies could have been due to emotion and people investing simply based on expectations that the market would rise and not on actual market strength. There is no clear answer and the past doesn’t dictate the future performance.
Thus, investing on seasonal trends may be preferable to chartists and qualitative researchers which a short-term disposition who are looking for a quick gain based on a perceived market anomaly before selling their shares and searching for their next move. Keep in mind that investing based on season trends can be full of transaction costs, capital gains tax, and increased risk. For those that invest for the long-term, they may prefer to focus on dollar-cost averaging and the overall rise of the market over time, not what’s changing month to month.
However you decide to invest, it is helpful to be aware of historical patterns and the various strategies that some investors apply at different times of the year. The more you learn, the better prepared you can be to make your own investment decisions.
Motif Investing is an excellent destination for testing your own investment strategies, both short term and long term.
Photo Credit: https://www.flickr.com/photos/rkramer62/14647751643
3 Investopedia, http://www.investopedia.com/terms/s/sell-in-may-and-go-away.asp
4 Investopedia, http://www.investopedia.com/articles/05/seasonaltrends.asp
5 Business Insider, http://www.businessinsider.com/santa-claus-rally-history-2014-12
6 Wikipedia, http://en.wikipedia.org/wiki/January_barometer
7 Business Insider, http://www.businessinsider.com/january-effect-seasonal-stock-trends-2015-1
8 Investopedia, http://www.investopedia.com/terms/j/januaryeffect.asp
9 Fidelity, https://www.fidelity.com/learning-center/trading-investing/markets-sectors/sector-seasonality