Every season brings changes in how weather behaves, how people behave — and how markets behave. So is investing according to the seasons really a wise idea?
Spring has sprung in Victoria. Ocean-fresh air and sunshine bring a heightened sense of optimism for local business owners readying for the start of tourist season. Walking past the shops on Government Street, some already buzzing with tourists, one can make some profitable portfolio parallels. Spring and summer months bring more visitors to town for shopping, dining and more — something that happens year after year. We call this “seasonality,” and for investors, the changing seasons bring with them important lessons to be learned.
Seasonal investing lessons have been summed up with cutesy sayings like “Buy when it snows, sell when it goes; sell in May and go away.” Market pundits like to espouse this saying as first-quarter earnings ebb to a finish, tax returns are filed and refunds arrive in the mail. Sayings like this suggest investors would be better served selling equities ahead of the summer doldrums and holding cash until November.
In fact, there are pundits who swear the seasonal buying and selling strategy will, on average, generate above-average rates of return. One cannot help but think that this saying came into common vernacular after the great stock market crash in October 1929 and again in October 1987. If you want a more recent example, recall the infamous Monday, August 24, 2015, event when, in the first 15 minutes of trading, the Dow Jones Industrial Average plunged nearly 1,000 points. Who wants to ride that kind of volatility? The answer, of course, is no one.
Look Before You Leap
Before you jump on the seasonal bandwagon, you need to keep the following facts front and centre. First, seasonal investing requires a great deal of knowledge, dedication and time. Plus, you have execution costs to consider as you buy and sell — plus, selling generates a potential tax issue.
Second, the historical evidence for seasonal investing is mixed and data dependent. For example, over a 20- or 30-year time horizon, on average the strategy can work (depends on your start and end points) but the evidence also suggests that in the short run (over three or four years) it might not.
In 2014, the S&P 500 delivered a 9 per cent return; in 2013 it gained 11.2 per cent; and in 2009 the market was up 20 per cent in the May to October period. That’s a lot of money to leave on the table, and in our experience, most investors will throw in the towel and abandon the strategy. Plus, the statistical evidence we reviewed is based on the S&P 500 index, which few people own. In reality, you are more likely to own a portfolio of mutual funds, ETFs (exchange-traded funds) and stocks.
When is Seasonal Investing Right for Your Portfolio?
The problem with seasonality is that it’s always changing, just like the weather. One year the pattern might work from April to September; in the next year it could be June to December. In practice, this means that seasonal investing won’t work for the average investor doing it themselves. However, it is a great tool to aid performance when you use it in conjunction with fundamental and technical analyses.
For example, there is enough statistical evidence to look at trimming broad market exposure in May in favour of consumer staples, gold stocks and natural gas ETFs. (For the aggressive investor, use individual stocks that display good momentum and relative strength.) Then in November, investors should overweight broad markets, financials, consumer discretionary and materials.
A Simpler Approach
There is, however, a simpler approach. Horizons Exchange Traded funds offers the Seasonal Rotation ETF (symbol HAC) that you can ladder into your portfolio. By doing so, you will be creating a tactical trading strategy in your portfolio that uses a strict discipline to increase and decrease your overall equity and cash exposure.
Do keep in mind that seasonality requires patience and discipline. If you recall, during the month of January 2016, the Dow plunged 1,659 points or 9.5 per cent in the first three weeks of trading. Disciplined investors were rewarded because the index not only recovered its full loss but added nearly 2 per cent by mid-May.
If ETFs are not your thing, then perhaps think of writing covered calls on your equity positions. A Call Option is a fixed-term contract that gives the owner the right to buy a security at a specific price for a specified time. For example, suppose you own 500 shares of TD Bank stock. On May 19, the stock is trading at $66 and you don’t want to sell it even though it might drift lower during the summer. You could sell five August Calls with a $68 strike price for approximately $1.00 share. All things being equal, if TD Bank stock stays below $68 until the third Friday of August, you would earn an extra $500 on your investment. It’s important to note that there are risks, so you should consult a qualified financial adviser before using option strategies.
We’ve always found that when we present to clients on investment strategies, stock market seasonality is an easy concept for most of
them to grasp because of the easy cause-and- effect analogies. Winter comes and stores can’t stock enough shovels and road salt. Spring arrives and stores stop selling parkas and sell more sunglasses and sunscreen. Financial markets develop similar cause-and-effect patterns or historical tendencies and averages. Until they don’t.
Seasonal investing strategies are best used in combination with other investment disciplines, including solid stories (fundamentals) and smart entry and exit strategies (technical analysis). For additional information about seasonal investing, we strongly recommend you check out equityclock.com, alphamountain.com or investmentreview.com.
And finally, always remember the wisdom of economist John Maynard Keynes: Markets can stay irrational longer than you can stay solvent.