Seasonality

iStock_000085081023_SmallIn this blog I’ll examine the old “sell in May and go away” seasonal pattern associated with risky assets. It’s timely to consider this pattern since the markets are now entering the seasonally weak period. Furthermore, stock market performance has been relatively weak in a number of recent “strong periods,” such as in January 2016, November 2015 through January 2016, and November 2015 through April 2016, which often provides a foreboding tell of additional weakness during the traditional seasonal weak period of May through October.

Seasonality as a trading edge is also worth considering because trend following has become very trendy these days, with billions of dollars flowing into this discipline every year via managed futures funds. The problem with these flows is that the effectiveness of trend following diminishes as more assets are devoted to the discipline, since trend following is naturally capacity constrained due to high turnover (>200%) and the liquid demanding nature of trading. It seems that trend following is crowded.

At this point in time, it may be interesting to examine other market timing signals as an alternative way to add and reduce risk exposure. One such approach is seasonality, which is probably underutilized by the asset class trading community and thus might be more effective than trend following over the near term.

The seasonal pattern has been well known for decades – the stock market’s best period is from November through April, and its poor-performing period is from May to October. This is not the case every year, but on average this seasonal pattern has held up really well with stock markets around the world for decades.

Academics call this pattern the Halloween effect since the buy signal is generated by buying at the close on October 31 every year and the sell signal is on every April 30. What’s amazing is that seasonality has not been arbitraged away, even though the cost of implementing a seasonal trading system has been low since the 1980s. The old adage of “sell in May and go away” still works! (more…)