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Being Street Smart

Sy Harding

Is Stock Market Seasonality a Myth After All? December 24, 2009.

What happened to the market’s seasonal patterns this year?

For many years I have touted the consistency and power of the stock market’s seasonality, the tendency of the market to make most of its gains between November and April, and to experience most of its corrections, bear market losses, and crashes between May and October.

In my 1999 book, Riding the Bear – How to Prosper in the Coming Bear Market, I even introduced my Seasonal Timing Strategy as a means of continuing to make profits in the strong 1990’s bull market, and then go on to also prosper in the serious bear market I was expecting. My seasonal strategy improves on the market’s normal seasonal pattern by using a technical momentum indicator to better time the entries in the fall and exits in the spring.

Over the next ten years, a period that experienced two of the most severe bear markets since the 1929 crash, my STS produced a compounded gain of 132%, compared to the S&P 500 losing 13%, in one of the market’s worst ten year periods ever. Yet, during the ten years my seasonal strategy had only one down year, last year. Even then it was down only 3.6% in a bear market year in which the S&P 500 lost 36%.

But seasonality didn’t show up this year. The market suffered a mini-crash from December to its March low, which was in the middle of its favorable season. It began an explosive rally off the March low, which helped a seasonal strategy recover some. But the market continued to rally all through the summer and fall, usually its unfavorable season when a seasonal investor is out of the market. So it’s been a strange year for seasonality. In spite of re-entering in October, my STS strategy is down 4.4% for the year, after being down 3.6% last year.

So has seasonality gone away? Was it perhaps only a myth to begin with?

Not hardly.

My own books have documented the phenomenon going back to 1950, finding that a seasonal strategy would have more than doubled a buy and hold strategy, in spite of occasional years when it did not match the market’s performance.

An academic study by Ben Jacobsen, of the New Zealand Institute of Advanced Study, published in the American Economic Review in 2002 concludes, “Surprisingly we found this inherited wisdom of Sell in May and Go Away to be true in 36 of 37 developed and emerging markets. Evidence shows that in the UK the effect has been noticeable since 1694.”

An academic study in 2008 devoted solely to the U.S. market, published in The Financial Review, found that, “All U.S. stock market sectors, and 48 out of 49 industries, perform better during winter than summer in our sampling from 1926-2006.”

The study noted that, “A trading strategy based on this anomaly would be highly profitable in many countries. The risk-adjusted outperformance ranges between 1.5% and 8.9% annually depending on the country being considered. The effect is robust over time, economically significant, unlikely to be caused by data-mining, and not related to taking excess risk.”

Those academic studies used month-end dates, and six-months in, six-months out seasonal periods, as their purpose was only to determine if the market has a consistent seasonal pattern, and concluded that it most definitely does.

But obviously the market does not begin or end a rally on the same day each year.

My STS strategy uses a technical momentum indicator to better define the exits and re-entries, and by doing so its seasons vary year to year between 4 and 7 months in length. By doing so it almost doubles the excellent basic seasonal performance revealed in the academic studies.

So what happened to the market’s seasonality this year?

It’s interesting that 2003 was a similar year, in fact identical in so many ways as to be spooky.

In 2003 Washington had also launched what was then a record super-sized economic stimulus package, to pull the economy out of the 2001 recession, a recession that had been exacerbated by the 9/11 terrorist attacks. As with this year, interest rates had been cut to extreme lows, and massive amounts of excess liquidity were flooded into the financial system.

And, identical to what happened this year, early in 2003 the stock market had doubts that the stimulus efforts were going to work, and declined in what is typically its favorable season, to a low in early March.

Also identical to this year, in 2003 the market then launched off that early March low into an impressive rally that continued through the summer, typically the market’s unfavorable season.

So in answer to the question of what happened to seasonality this year, it’s clear that in those rare years when the financial system is flooded with massive amounts of excess liquidity to rescue the economy, the excess liquidity also overwhelms the market’s normal seasonal pattern for the year.

It will be interesting to see if the similarities to 2003 continue, since once November, 2003 arrived, the beginning of the market’s next favorable season, the rally actually accelerated, and didn’t end until March of the following year.

Meanwhile, in 2003 seasonality had not gone away permanently. It returned and served extremely well as a strategy from 2004 through 2008, including through another severe bear market. Nor did its underperformance in 2003 affect its long-term performance.

And seasonality it has not gone away permanently this time.

That probably means we should expect the market to run into problems sometime during the summer or fall months next year.

Sy Harding is editor of www.StreetSmartReport.com, and the free daily market blog, www.streetsmartpost.com.

Sy Harding is CEO of Asset Management Research Corp., author of 1999′s Riding the Bear and 2007′s Beat the Market the Easy Way, editor of www.StreetSmartReport.com, and www.SyHardingblog.com.

Article Source:http://www.articlesbase.com/investing-articles/is-stock-market-seasonality-a-myth-after-all-december-24-2009-1622560.html