Stock Market Seasonality: Is it Real?

Stock market performance is often attributed to supposedly predictable seasonal fluctuations, but there are many economists who regard this as taking a far too broad look at movements. They say you can find a pattern in almost anything at the right level of detail, but whether it’s a relevant signal or not is another matter entirely.

There is of course plenty of evidence that the time of year has a correlation with the stock markets in both the US and other countries. The old phrase ‘sell in May and go away’, also known as the Halloween effect is a perfect example of how seasonality works, and it holds that stock performance is generally weaker during the summer than the winter. The following table shows that in the 40 year recorded period, the Halloween effect mostly held true, with strongest S&P 500 performance coming in winter months.

Interestingly, the Halloween month is generally positive, which could mean that investors have tried to front-run seasonality. The end of the year is almost always strong, and speculators may have tried to jump on the bandwagon early. February is also a notable exception to the trend.

Skeptics generally dismiss seasonal patterns as being a waste of time, but if they’re considered more of a likely trend than a definite pattern, they certainly have their uses. In most cases, the chances of seasonality being correct aren’t much more than 50 percent, but this is still a significant indicator and barometer that you can use.

So what causes seasonality?

Early seasonality was often the result of harvests. Obviously grain will be cheaper right after a good harvest and more expensive when it has been stored (and used up) for almost a year. You would also expect swimsuit manufacturers to do well in late spring and early summer while snow mobile manufacturers would do well in late fall and early winter. So there is some basis for seasonality. And the sell in May theory may have a basis in the idea that many traders take vacations in the summer so demand for shares are just lower since there are fewer traders bidding them up.

Another commonly used answer is that society as a whole is habitual, and this extends right from consumer spending in grocery stores, to how investors choose to manage their portfolio. Christmas is an obvious example of this buying pattern. And mutual funds tend to do year end buying to spruce up their portfolios with “winners” in December adding to the demand for already pricey stocks in December.

Taking Advantage of Seasonality

In theory then, predicting seasonality in the stock markets allows you to match and exceed their performances, while minimizing your exposure to risk. Of course, this isn’t necessarily going to be the case for very short term positions, in which it’s harder to argue that the time of year has any effect, but it’s certainly a useful way of looking at things in the mid- to long-term.

You’re also required to trace broad indexes rather than individual stocks. After all, this is a general market trend, not an indicative pattern to look for on a price chart.

The argument could also be made that distribution of economic announcements may play a part in affecting which times of the year perform in different ways. Alpari.co.uk has an economic calendar that you can use to find out when the next market-moving announcements are going to be made.

Seasonality then, is a theory which has evidence to back it up, and which can be useful if used as more of a general trend than a specific indicator.

Image courtesy of Franky242 / FreeDigitalPhotos.net”.