Warning – Storm season ahead for stock market (May 6 - Oct 27)!
by Brooke Thackray, AlphaMountain Investments
Introduction
Different locations in North America are more prone to storms than others depending on their geography and proximity to water. Regardless of where you live, a storm can hit at anytime, but there is typically one season of the year that is more prone to storms than others. Even when the storm season arrives, there is no guarantee that a storm will hit. Sometimes a storm may start to develop far away and then fade. In some seasons, a storm may not develop at all. The fact is that depending on your location, there is a probability distribution for storms during the year. Some months tend to have more storms than others. Hurricane season in Florida lasts from June 1st to November 30th. Although a hurricane can hit at any time during hurricane season, there is a higher probability of a hurricane hiƫng Florida in September than any other month.
Seasonal investing is akin to storm forecasting, as it is centred around probability distributions. Seasonal investing takes into account the probability of return distribution of the six month favorable and six month unfavorable periods. In the favorable six month period for stocks (October 28th to May 5th), the stock market tends to produce larger gains and fewer losses, when compared to the other six months of the year.
It might be argued that weather conditions at certain times of the year are responsible for a storm’s development, rather than the time of year itself. Although this is true, there is stati stical evidence that the stock market performs beƩer for six months of the year and is less susceptible to corrections than the other six months of the year. In academic circles, the favorable-unfavorable six month effect for stocks is called the Halloween Effect.
The Halloween Effect has been the subject of numerous academic studies. The most exhaustive of which is a study from October 2012 entitled “The Halloween Indicator: Everywhere and all the time” by Ben Jacobsen and Cherry Y. Zhang from Massey University in New Zealand. Jacobsen and Zhang looked at more than 300 years or market data in 108 countries. The study found stock market returns from November through April are on average 4.52% greater than those over the summer. The average difference between November-April and May-October returns is 6.25% over the past 50 years. A “Sell in May” trading strategy beats the market more than 80% of the time over 5 year horizons.
The stock market is “richly valued” by a number of metrics. Although these valuations indicate that the stock market is susceptible to a correction, it does not indicate if and when there will be a correction. In other words, valuation metrics are not good timing tools. They are still useful indicators, illustrating the susceptibility of the stock market to a correction and if a correction were to occur the possible magnitude of the correction.
The problem isn’t just that the stock market is richly valued, increasing the chances of a correction on a go-forward basis, there is an additional layer of risk with the S&P 500 just entering its six month unfavorable period for stocks (May 6th to October 27th) where most large losses have historically occurred. Puƫng these factors together elevates the risk that the stock market could suffer a correction this summer.
If there is one time of the year that makes sense for investors to lower the risk in their portfolios, it is the six month unfavorable period for stocks. The stock market rallied strongly aŌer the U.S. election based upon the belief that Trump would be able to implement pro-business policies. So far, he has stumbled with implementation and it looks like future actions are going to take longer than expected. There may be a storm ahead this summer, but there is shelter elsewhere. All is not lost, as there are investments that tend to perform well in the six month unfavorable period, including certain sectors of stock and fixed income market.
Read/Download the complete 12-page report below:
Thackray Seasonal Report Storm Warning 2017-May-05 by dpbasic on Scribd
