If you're an investor, you're probably always on the lookout for ways to maximize your returns. One strategy that you may have heard of is referred to as "seasonality." This denotes a systematic tendency for certain stocks or indexes to outperform at certain times of the year. But what exactly is seasonality, and why does it exist? Read on to find out.
An Explanation of Stock Market Seasonality
The first thing to understand about seasonality is that it isn't necessarily tied to any specific physical phenomena. Rather, it's more of a statistical quirk that appears to arise due purely to random chance. Nevertheless, even though the underlying cause may be a matter of probability, investors can still profit from seasonality if they understand how it works and are willing to take some calculated risks keeping in mind past performance is not a guarantee of future gains.
To analyze seasonality trends in the stock market we used the following metrics:
Average returns by month: This is the average of all historical returns in a month. It provides information regarding the performance of the index during a particular month.
Gain frequency by month: This statistics is obtained by dividing the number of positive returns in a month by the number of observations in that month. This provides an indication of the historical probability that a positive performance was observed during a particular month of the year.
Major US Stock Market Indeces: Seasonality Trends - Monthly Gain Frequency by country:
Examples of seasonality by month: January
One of the most commonly cited examples of seasonality in the stock market is the so-called "January effect." This is the tendency for small-cap stocks (i.e., those with a market capitalization of $2 billion or less) to outperform large-cap stocks (those with a market cap of $10 billion or more) during the month of January.
The January effect was first documented in 1942 by Sidney Wachtel, who found that small-cap stocks had outperformed large-caps by an average of three percent during the month in question since 1925. While there are a number of theories as to why this might be the case, the most likely explanation is that investors sell off their losing positions near the end of the calendar year for tax purposes, creating an artificially depressed demand for small-cap stocks. Once these positions have been sold, investors are free to buy back into them at lower prices in January, driving up demand and prices in the process.
Other good months for the stock market: November, December, and April
Of course, while the January effect is perhaps the best-known example of seasonality in the stock market, it's far from being the only one. In fact, studies have shown that there are significant differences in stock performance based on what time of year it is. For example, research has shown that returns tend to be highest in November, December, and April—a phenomenon that has come to be known as the "Halloween Effect." One possible explanation for this pattern is that it corresponds with times when investors are more likely to have cash on hand (i.e., following big holidays like Thanksgiving and Christmas). With extra cash available, these investors are able then to put this money into their portfolios, thus driving up demand and prices.
November, December and April are usually the best months for the stock market
While September is a typical risk-off month, equity markets tend to rally in November, December, and April. April in particular, shows the highest average returns for the main stock indices of advanced countries.
In these months of the year, the S&P 500 (US 500) index grew by an average of 1.4%, 1.3%, and 1.6%, respectively. The percentage of times that the S&P 500 (US 500) has posted positive returns is also very high, 68%, 74%, and 71% of cases respectively.
The Nasdaq 100 (US 100) even outperformed the S&P 500 in terms of average returns in November (+2.2%), December (+1.5%), and April (+1.6%).
The Dow Jones (USA 30) grew by 1.4%, 1.5%, and 2.1%, respectively, as well as the German DAX (DAX 30).
In short, seasonality is a statistical quirk that leads certain stocks or indexes to outperform at certain times of year. While there's no foolproof way to profit from seasonality—since it's ultimately driven by chance—investors who understand how it works can still use it to their advantage. We suggest that you contact a registered adviser.
Wealth & Asset Management
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Lyon Bern, LLC is a Registered Investment Adviser and is in the business of consulting and advising its clients in wealth and asset management. Each client's diversification between Lyon Bern's portfolios will be made individually and based on the client's Investment Policy Statement. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product referred to directly or indirectly in this document will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Lyon Bern, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional investment advisor. A copy of our current written investment advisory agreement discussing our advisory services and fees is available for review upon request.