Stock market seasonality mid-year update

Even with the S&P 500 up a whopping 107% in the bull market that began three years ago, investors were still pulling their money out of stocks and mutual funds in the first half of 2012, and pouring it into the perceived safety of Treasury bonds.

You can’t blame them. It’s been an extremely rough time for most since the market peak in 2000. Two full-fledged recessions in the economy in the subsequent eight years, two severe bear markets, with the market losing 50% of its value in each.

Shorter-term, every time they started to become comfortable again in the current bull market that began in 2009, buy and hold investors have been hammered by lesser shocks. In each of the last two summers the economic recovery temporarily stalled, and the S&P 500 declined 15% to 20% in corrections before recovering. There are real concerns of a repeat this year.

But through it all, regardless of recessions or recoveries in the economy, bull or bear markets, no matter which party was in the White House or controlled Congress, the market’s seasonality patterns continued as they have for many decades (for more than a hundred years according to some academic studies).

I refer first to the annual seasonality of the market making most of its gains in the winter months, and experiencing most of its corrections in its summer months, the so-called ‘Sell in May and Go Away’ pattern.

Some refer to it as a theory, or an iffy thing, because the market does not experience a correction in its unfavorable season every year. But it’s not a theory. It’s a well-documented fact that the annual seasonal pattern works out so often that over time it significantly outperforms the market. That out-performance has been documented and verified by numerous academic studies, and the performance of investment strategies based on the pattern.

For instance, Mark Hulbert of Hulbert Financial Digest fame has been tracking investment newsletter performance for more than 30 years. In April he published an article reporting the 10-year performance of several methods of harnessing annual seasonality as an investing strategy from 2002 to 2012.

His findings were that the market experienced an average annualized return of only 5.4% over the 10-year period, often referred to as the ‘lost decade’. But the simple strategy of selling May 1st and buying back November 1 (the basic Sell in May and Go Away strategy) produced an average annual gain of 7.0%, 30% more than the market’s gains, and just as importantly it did so while taking only 60% of market risk.

He also reported that my newsletter’s Seasonal Timing Strategy, in which I combine a technical indicator with the seasonal pattern, produced an average annual return of 9.0%, outperforming the market by 67% over the period, while also taking only 60% of market risk. (It was up 15.8% last year, compared to the Dow being up 5.5% and the Nasdaq being down 1.8%).

No lost decade for those utilizing the market’s seasonality.

So where do we stand now within the annual seasonal pattern?

The exit signal for the basic Sell in May and Go Away strategy was, as always, May 1. My Seasonal Timing Strategy triggered its exit signal on April 20. So far so good. The re-entry signal for the basic Sell in May strategy will be November 1. My seasonal strategy will give its re-entry sometime between October 16 and the end of November, depending on what the additional technical indicator I use says at the time.

However, of more interest to me right now are the shorter-term seasonal patterns, which I incorporate in my non-seasonal market-timing strategy.

Those shorter-term patterns include 1) that the market usually has a short-term summer rally within its unfavorable summer season. 2) the market is usually positive in the days around the July 4 holiday, and in the days leading up to July’s options expirations on the 3rd Friday of the month. So far, both of those patterns have also held true to their history.

The next short-term pattern is that the second half of July tends to be negative (about 70% of the time). Some of the declines in the second half of July have been notable. Last year certainly was. After a summer rally from June into mid-July last year, the market topped out on July 22 and the S&P 500 lost 18% over the next three weeks.

Seasonal patterns, both the annual pattern and the short-term patterns, seem to be something to think about again this year, as we arrive at mid-July with economic reports in the U.S., Europe, and Asia looking as dismal as they did for a while last summer, the eurozone debt crisis again in the headlines, and Fed Chairman Bernanke indicating last week that any hoped for rescue efforts by the Fed are not in the cards any time soon.