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Must Read: Independent Study Confirms Market Seasonality

  • Written by Syndicated Publisher No Comments Comments
    May 7, 2013

    In April each year, as May 1 approaches, a few analysts and columnists looking for something timely to write about jump on Sell In May as a likely topic. And so the articles begin, suggesting why Sell In May won’t work this year, or why it’s likely to, or how it could be adjusted this time to maybe just cutting back some, or by continuing to buy but substituting this or that foreign market, or defensive stocks, or whatever.

    The articles are never the result of research to see if the data would support the thesis of monkeying with the remarkable consistency of the market’s seasonality, but rely on maybes, and theories, and various forms of analyzing current economic or political situations or conditions.

    So it’s always good to see someone put the time and expense into independently gathering many decades of data, compiling and analyzing it, and writing an opinion based on facts.

    One of the most recent to do so is Walter Zimmerman, chief technical analyst at United-ICAP.

    His work is reported in an article on Business Insiders titled ‘Here’s How Rich You’d Be If You Did the ‘Sell in May and Go Away’ trade since 1950’   http://www.businessinsider.com/the-sell-in-may-and-go-away-trade-2013-5

    This is Zimmerman’s chart of the difference between the market’s favorable season and its unfavorable season tracked back to 1950.

     sell in may

    The chart is based on three approaches to investing $10,000 in the Dow in 1950.

    The horizontal red line at the bottom represents an investor who only invested in the unfavorable season of May 1 to October 31, and each year switched out of the market into cash for that year’s favorable season of Nov. 1 to April 31. That investor would have a loss of $1,251 (12.2%) over the 63 years.

    The second investor simply bought and held the Dow through the entire period, and would have a gain of $659,116. Not bad at all.

    But the green line represents the performance of an investor who followed the ‘Sell in May’ strategy of switching into the market on Nov. 1 and back out into cash on May. 1. The investor’s compounded return would be $943,130, or 43% more than buy and hold.

    And the chart does not reveal the additional attraction that the over-performance of the seasonal approach was achieved while taking only 50% of market risk (out of the market 6 months every year), and avoiding the worst of corrections that might be difficult to hold through and result is selling at the lows. (Corrections and crashes obviously tend to take place unexpectedly in the unfavorable seasons, which is the only reason a seasonal strategy works so well).

    Interestingly, Zimmerman noted that from his research, “This advice has shined the brightest in those years with the most extreme bullish sentiment going into May.”

    Misunderstanding how seasonality works.

    Each year when the market does not immediately top out in early May, the articles then begin to pile up about how seasonality doesn’t work, about how it’s an ‘iffy’ thing.

    But the facts are that all seasonality is saying is that the market is most likely to be lower November 1 than on May 1. And indeed over the years when there were corrections they most often took place in the fall, to lows in October. It has only been in the last three years that May 1 was so specifically close to tops.

    Meanwhile, numerous academic studies of the market going back many decades have confirmed that even though there is not a correction every year, and sometimes for several years in a row, an investor who simply bought the Dow or S&P 500 via an index mutual fund or etf on November 1 each year, and moved to cash on May 1 outperformed the market over the long-term by a significant amount.

    Does that mean it outperforms the market in every individual year? No. But then there is no strategy that does, most particularly a buy and hold strategy.

    Yet in spite of years of proof piling up, investors and the financial media still struggle with the thought of such simplicity outperforming the market, and therefore the majority of mutual funds and professional money-managers, and doing so while taking only 50% of market risk (out of the market 6 months each year).

    Even many of those who happily benefit by following it don’t always remember that it is strictly a mechanical strategy. One of its most important attributes is that it is mechanical and therefore avoids the problem that most often harms performance, the intrusion of the emotions of fear or greed, excess bullishness or bearishness.

    Each year there are reasons to think that this time is different, that seasonality won’t work. In the fall, as the re-entry date approaches the emotion is usually fear. There has often been a summer correction brought on by worrisome conditions that have investors and the media expecting more downside. In the other direction, by the time the exit date approaches in the spring there has usually been an impressive favorable season rally that has reversed sentiment, convincing many that this time is different, that seasonality will not be a factor, that the market will most likely continue to climb through its unfavorable season.

    And there are just enough years when that does happen to keep investors and the media skeptical, describing seasonality as ‘iffy’, and those following the strategy tempted to allow short-term emotions to interfere.

    Our Seasonal Timing Strategy is a further improvement over the ‘Sell in May and Go Away’ strategy, for the simple reason that obviously the market does not begin to rally on the same day (Nov. 1) each year, or roll over to the downside on the same day in the spring (May 1). In fact Nov. 1 and May 1 are not even the best average days to use if one is going to use just a calendar for the decisions.

    So back in the 1990s we researched the best average calendar days historically, and then added the short-term momentum reversal indicator MACD to determine whether the market was reversing or not as those calendar dates arrived. If MACD is on a sell signal as the earliest calendar entry date arrives, the re-entry is simply delayed until MACD reverses to a buy signal. And in the spring, if MACD is still on a buy signal when the earliest calendar exit date arrives, the exit is simply delayed until MACD reverses to a sell signal. The result is a seasonal strategy in which the seasons can be as short as 5 months or as long as 7 months , depending on what the market is doing each year. The improvement is dramatic, whether back-tested over the last 70 years, or in real-time in our portfolio since 1999.

    But the basic truth and consistency of the market’s seasonality is similar in virtually all charts.

    We have always compared seasonal strategies only to buy and hold, as we can’t imagine why anyone would invest only in the unfavorable season.

    But by also charting the market’s performance in its unfavorable seasons, Zimmerman’s chart not only shows the advantage of harnessing the market’s seasonality but also the poor odds of making further gains in the unfavorable season with long-side positions.

    To see the actual performance figures and more details on seasonality click here: Seasonal Timing Strategy

    To read my weekend newspaper column click here:  Did This Week’s Critical Economic Reports Vindicate Market’s Resilience-

    To read previous week’s column click here:   Here’s Why Next Week’s Economic Reports Are The Most Critical in Months!

    Subscribers to Street Smart Report: In addition to the charts and recommendations in the subscribers’  ‘Premium Content’ area of this blog, the next issue of the newsletter will be out on Wednesday in your secure area of the Street Smart Report website.

    Non-subscribers: We recently updated the sample issue of the newsletter to a more recent issue you might find interesting. Click here to view it: Sample issue of Street Smart Report newsletter

    Images: Flickr (licence attribution)

    About The Author

     

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

    It provides two model portfolios as guides. One is based on ourSeasonal Timing Strategy, one on our Market-Timing Strategy.

    In depth updates are provided every Wednesday, with interim ‘hotline’ updates every time we make a trade. An 8-page traditional newsletter Street Smart Report is provided on the website every 3 weeks, in pdf format for viewing or printing out.

    There is the Street Smart School of online technical analysis ‘seminars’,commentaries to keep you ‘street smart’ about Wall Street, and much more. 

     

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