There is a surprisingly robust seasonal effect in the stock market. It suggests that, despite the recent market turmoil, the coming days may be a good time to increase your stock exposure at least until next spring. An examination across history and countries has found weak performance for stocks over the summer months (May-October), and far better performance in the winter months (November-April).

It’s important to note that this is by no means a sure thing every year. In fact, it works less than half the time, but on average you would have improved your returns over buy and hold using this strategy. Also, even though you can’t count on it each year, over a period of 5 years, you have an eight in ten chance of coming out ahead of buy and hold with this strategy based on history. 


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Remember that an appropriate test of most investment strategies is not how often it works, but how much it makes. Plus, when investing with relatively simple strategies winning eight times out of ten is considered very good.

Avoid The Summer

It is of note that the main value of this strategy is in avoiding the summer months by selling in May, after that returns for stocks are generally bad, often worse than for bonds. Indeed, we appear to have seen that in 2018 for many markets given the recent drop. As such, during the winter months the stock market can basically produce its gains for the year, overcoming the drag of poor summer performance.

A Puzzle

This is a strange effect. The authors of the research on the topic Ben Jacobsen and Cherry Zhang in their most recent update to the research note that it seems to “defy economic gravity.” This is because it should not be so simple to find profitable strategies in the stock market. Indeed, many effects that appear to be profitable can lose their edge after they are discovered, either because the effect was spurious in the first place, or because traders arbitrage away any benefit from the strategy.

However, the Halloween indicator for the stock market appears to have persisted since its initial examination in 2002, and the idea of selling in May has been part of investment folklore well before that. In fact, there is some suggestion that the impact of the effect may even be increasing over the past half-century. It is still unclear why this theory holds up, which is perhaps one of the weaknesses of the strategy, though researchers believe that summer vacations may be the reasons why summer returns are weaker. It is also possible that the strategy is so simplistic that professional investors are unwilling to employ something quite so basic, in an era when investing is becoming ever more sophisticated and performance edges become harder to sustain.

Does It Really Work?

As such, it is quite right to be skeptical of the sell in May effect. In fact, when I first came across it, my goal was to write a piece explaining why it couldn’t work. However, the data doesn’t appear to support that view, and so my view changed. It’s been tested across over a hundred different stock markets. It appears to work in Iran, Mongolia and Ghana as well as most of the major markets you’re familiar with including the U.S. It’s been found to persist across different time periods, and it holds up to the rigor of statistical testing, such that it’s unlikely to be merely noise and not driven by just a one-off big summer market crash. Of course, that’s still no guarantee that it will work in future, but as statistical testing goes, the results are strong.

Another factor to consider for taxable investors, is that the strategy would push you into realizing short-term capital gains in many years to the extent you are selling holdings after less than a year because you might trade your whole portfolio twice a year if following the strategy. This may offset some of the potential benefits. However, in tax-sheltered accounts such as 401(k)s and IRAs this is typically not a concern.

The Halloween indicator isn’t the only seasonal effect in the market, but it may be one of the more robust. As with any single indicator you should exercise caution and consider other factors, including potentially elevated market valuations currently and your own portfolio needs. However, the Halloween indicator is remarkably hard to dismiss. It may improve returns by a few percentage points each year, and that should not be overlooked.

 

This article was written by Simon Moore from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network. 

Raman Chopra, B.Eng.,CFP profile photo
Raman Chopra, B.Eng.,CFP
Agency Director & Managing Partner
iFreedom Financial Solutions
Office : 604-607-4909