Many of you have heard the old stock market saying “sell in May and go away". In this report I will delve further into this seasonal pattern and look at ways that you can profit from seasonality studies. We will use the US S&P 500 as our benchmark index not the UK FTSE100 which has not followed seasonality as well.
Before I go any further I have to warn that past performance is no guarantee to future results, however, with a long established track record this system is worth considering. Also, my aim here is to look at the facts and how to profit, rather than speculating why markets tend to be weaker over the summer months.
In brief the S P500 historically has been stronger between November to April than the May to October period. By staying out of the stock market and going in to cash in on the weaker period a better return can be achieved than a simple buy and hold 12 month strategy. Also your risk can be reduced, remember, each month you are invested in the market you are taking risk, by being out of the market for 6 months of the year you have just reduced your risk by 50%
A study of price action for the S&P 500 Index from April 30, 1945, through April 21, 2006, shows interesting results. The S&P 500 advanced an average of 7.1% during the November to April period over that span (without dividends reinvested), it posted an average gain of only 1.5% from May through October. What's more, the November through April period outperformed May through October 68% of the time.
History shows that the S&P 500's worst month is September, and that the worst three-month period is the third quarter. October is historically a month in which the market establishes a bottom, so the S&P 500 enters November at a fairly low level compared to other months. This gives the November through April period the advantage of starting at a lower base. January also tends to be a strong month with New Year optimism and pension funds tend to invest new money, April also sees many individuals add to their retirement pension plans.
An interesting study was done by the the Stock Trader's Almanac which demonstrated the power of seasonality. They tracked what would happen to a $10,000 investment in the stocks that make up the Dow Jones Industrial Average.
Money invested in the Dow stocks (you could use the DIA Exchange Traded Fund or a Wall Street spread bet to get the same effect) in the “best six months" and then switched to fixed income in the “worst six months" over 56 years grew to $544,323. But money invested in the Dow in the “worst six" and then switched to fixed income in the “best six" compounded to a loss of $272.
The chart below shows seasonality on the S&P500 and as you can see the gains come at the start and end of the year, being out of the market from May to 1st November.
How to trade seasonality's
A simple way would be a Financial Spread Bet. You could buy an up bet on the SPY which is the S&P500 tracking stock from the 1st November to 30th April and switch to cash for the weaker months. Your stop would be around 30% below the index, so if the S&P 500 was trading at 1300 the SPY would be at 130.00 your stop would be 30% below at 91.00. With a 30% stop you would not be worried about shorter term swings.
Another way would be to use fixed odds bets with www.betonmarkets.net You could use Bull bets to bet the S&P to go up from 1st November to 30th April and then use Bear bets to back the S&P to be no more than 3% higher on the 1st November than it was on the 30th April. So if the market is down you would win, if it goes sideways or up less than 3% you would win. You could change the 3% margin but this would reduce your returns, but it would make the bet safer.
What holds up over the summer?
So far we have looked at the whole S&P 500. If we look at the S&P sector indices since 1990 which is as far back as I could find reliable data, we see that defensive sectors hold up better during the May to October period and in fact show a gain.
One of the best sectors has been Consumer Staples, big boring, cash rich companies such as Proctor& Gamble, Altria, Pepsico, Colgate Palmolive and Cocoa Cola
So rather than go to cash during the weaker months you could park your money in the Select SPDR Consumer Staples ETF (XLP). The average return on this has been over 4.8%, so adding this to your 7.1% (the return from the positive months) you're on 11.9% return betting the S P 500. Over 15 years this has given a return of 8.8% per annum (without dividends reinvested).
As a trader or investor it's worth taking time to study seasonal patterns especially those with long track records. The above outlined strategy at its most basic would allow you to capture the majority of the year's stock market gains and still make a return on your investment from interest the months you are out of the market. A slightly higher risk strategy would be to rotate to a defensive sector in the weaker months which can be done cost effectively with an Exchange Traded Fund.
Vince Stanzione has produced a home study course to teach private investors how to benefit from trading financial Spread Bets and Fixed Odds priced at £347. For more information please visit http://www.fintrader.net or telephone 01189 47 66 30 (24hrs).