Using Seasonal and Cyclical Stock Market Patterns
“Those who cannot remember the past are condemned to repeat it,” proclaimed philosopher George Santayana. I believe that “those who study market history are bound to profit from it.”
There are three main seasonal and cyclical patterns that have stood the test of time and consistently provide me with an edge in managing my portfolios: the four-year Presidential Election/Stock Market Cycle, the Best Six Months Switching Strategy and January’s basket of indicators and trading strategies.
But first, let’s get one thing straight. While I am a strong proponent of historical and seasonal market patterns, I am always mindful that history never repeats itself exactly. I have used history as a guide for navigating current market conditions and anticipating trends with quite a degree of success over the years. What we try to get Stock Trader’s Almanac traders and investors to do is not necessarily follow historical patterns to a “T,” but to keep them in mind so they know when their radar should perk up.
Politics, Politics, Politics
What happens on Wall Street is inextricably linked to what transpires in Washington. For five decades, the Stock Trader’s Almanac has discussed and demonstrated this phenomenon. The Four-Year Presidential Election/Stock Market Cycle is the “Old Faithful” of indicators for us.
Presidential elections every four years have a profound impact on the economy and the stock market. Wars, recessions and bear markets tend to start or occur in the first half of the term, with prosperous times and bull markets in the latter half. This pattern is most compelling.
As you can see in Figure 1, the third year in the presidential term has the best performance, as there have been no Dow Jones industrial average losses in pre-election years since war-torn 1939. While pre-election years have generally had greater gains, election-year market performance has weakened, thanks in part recently to the year 2000’s bear market and undecided election and the year 2008’s financial crisis.
Figure 2 illustrates that November, December, January, March and April are the top months since 1950. Add in February, and you have an impressive trading strategy. These six consecutive months gained 14,654.27 Dow points in 62 years, up in 48 years and down in 14, while the remaining May through October months lost 1,654.97 points, up 37 times and down 25. Figure 3 shows the average change in the Dow Jones industrial average for both the best and worst six-month periods.
Seasonal Portfolio Management
Use of the words “buy” and “sell” has created some confusion when used in conjunction with our Best Six Months Switching Strategy. They are often interpreted literally, but this is not necessarily the situation. Exactly what action an individual investor takes when we issue our official fall buy or spring sell recommendation depends upon that individual’s goals and, most importantly, risk tolerance.
|Highlighted rows are post-election years.|
S&P 500 Index Gain (%)
|Source: Stock Trader’s Almanac.|
Over the years, there has been much debate regarding the efficacy of our January Barometer. Disbelievers in the January Barometer point to the fact that we include January’s S&P 500 change in the full-year results and that this detracts from the January Barometer’s predicative power for the rest of the year. In light of this debate, we calculated the January Barometer results with both the full-year results and the returns for the following 11 months (February through December). You can see these results, along with the S&P 500’s return for the Santa Claus Rally and the First Five Days in Table 1.
The Indicator Trifecta
The lack of a Santa Claus Rally has often been a preliminary indicator of tough times to come. This was the case recently in 2000 and 2008. A 4.0% decline in 2000 foreshadowed the bursting of the tech bubble and a 2.5% loss in 2008 preceded the second-worst bear market in history. There have been several instances in which a Santa Claus Rally preceded bad years or markets, so some caution is in order. This was the case in 2011, although the market did manage to recoup most of its losses to finish the year flat.
The last 40 up First Five Days were followed by full-year gains 34 times, an 85.0% accuracy ratio and a 13.6% average gain for all 40 years. In post-presidential election years, this indicator has a solid record. Just six of the last 15 post-election-year’s First Five Days showed gains. Only 1973 was a loser, coinciding with the start of a major bear market caused by Vietnam, Watergate and the Arab Oil Embargo. The other five post-election years gained 22.8% on average (1961, 1965, 1989, 1997 and 2009).
It’s incredible just how bullish it has been when all three indicators are positive. Since 1950, all three indicators have been positive 27 times and full-year gains followed 25 times. Losses occurred in 1966 (Vietnam) and just barely in 2011 (U.S. debt ceiling and European debt). Excluding January’s performance, the last 11 months of these years were up 24 times. The market’s crash in 1987 is the additional blemish on the record. Eleven-month average gains are impressive at 12.3%.
In 2013, the S&P posted its 17th best January gain of all time, completing the indicator trifecta. The January Barometer, Santa Claus Rally and First Five Days indicators were all positive this year—increasing the odds, but not guaranteeing, positive returns for 2013.