Timing the Market with Seasonality
If stock market cycles really exist, there should be evidence to support the idea. Seasonality indicators, identified in Yale Hirsch’s Stock Trader’s Almanac, provide some of that support.
When it comes to timing the market, the “best six months” is a clear winner for ease of use. It is based on stock market cycles and ties in nicely with the Wall Street adage “sell in May and go away”.
Briefly, you pick a basket of stocks (for example, the S&P 500) and buy the basket at the beginning of November. At the end of April, you sell. This even beats the Dogs of the Dow for ease.
This seasonal system has you in the market for 6 months and in cash for 6 months. However, like any stock market timing system, performance matters more than ease of use.
To observe the performance of the base strategy, we can use monthly historical data downloaded from Yahoo! Finance Historical Prices . For our example, we will study the S&P 500 for the 50-year period from November 1957 to October 2007. The Yahoo! stock market symbol for the S&P 500 index is ^GSPC.
For the 50 years, the Best 6 Months strategy had a gain 38 times, a loss 12 times, and an average annual gain of 7%. This was superior to the results of the worst 6 months of the year. The worst 6 months had 18 losses and less than a 1% average annual gain. If you could only invest for 6 months of the year this would be a great strategy.
However, buying the S&P 500 in November 1957 and holding for 50 years gives an average annual gain of 8.6%. For the 50 year test period that is a significant advantage over the seasonal timing system. Buy and hold would have returned $36 for every dollar invested. By comparison, the Best 6 Months strategy would have returned $22 for every dollar invested.
Before discarding the strategy, there are some things to consider. For example, the largest drawdown for the best 6 months was 16.6% versus the 21.4% max drawdown for the corresponding 12 months of buy and hold. The Best 6 Months strategy was also less volatile.
That may not be enough to make it interesting but there is also the point that you are in the market (and, therefore, taking risk) only 1/2 of the time. What you do with your money the other half of the time makes a big difference.
Suppose you could get a 1% return on your money during the worst 6 months of the year. It has often been possible to get a 6 month CD that returned 1%. That 1% extra per year for the 50 years of the test generated performance equal to buy and hold. And you are only exposed to market risk for half the year.
If it is reasonable to suppose you could get 1.5% for the worst 6 months (i.e., get an annualized rate of 3%) you would more than double the return of the seasonal stock market cycle strategy. For every dollar invested, you would have $47 at the end of 50 years.
There are other variations relying on technical indicators to adjust the entry and exit points to market conditions. The biggest problem with any timing system based on stock market cycles is being out of the market during a bull rally. It kills the performance of the system.
We are evaluating sites that explain these technical variations and will provide links. If you can recommend any sites, please use our contact form.
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Reviewed Sep 2016