During this time of year, investors should be aware of the seasonality of the stock market. We have entered what is typically considered the “strong six-month period” of the year for stock investing.
Stock Trader’s Almanac has performed a market seasonality study for many years, which shows that the period from November to April has outperformed the period from May to October. Hence the saying, “sell in May and go away.”
The study goes back to 1950 and shows an average return for the May to October time frame of 0.39 percent, while the period from November to April shows an average gain of 7.54 percent. The “bad” six months over the years had 39 up periods and 27 down periods. The “good” six months over the years had 51 up periods and 14 down ones.
Whether you average the returns, compound them or approach it in other ways, there is a clear dispersion between the two six-month periods. According to Dorsey Wright and Associates, if you compound the return over time, the “good” six months actually outperformed the overall Dow Jones industrial average by 7.54 to 7.03 percent. So there clearly appears to be a historical bias. During the past 30 years, there have only been four losing years in the November to April time frame (2008, 2007, 2000 and 1983), which were all around U.S. recessionary periods.
Seasonality is clearly in favor of the market moving higher, but a lot of investors rightly point out how equities are stretched in value. I agree with those assessments; however, as long as interest rates stay as low as they are, stock earning yields still have a tremendous advantage over bond yields. The earnings drop off that we’ve seen during the third quarter of 2015 has likely bottomed, and we believe earnings will improve going into next year. Accordingly, we think for the rest of the year momentum will favor stocks.
If you are looking to play year-end seasonal strength as a tactical move, consider small-capitalization stocks. Small-cap stocks lagged their large-cap counterparts during the rebound from the August lows, but money flowing into small-cap funds during November was strong. Using the Russell 2000 as a proxy for small-cap stocks, Ned Davis research reports small caps have risen during 81 percent of Decembers by an average of 2.7 percent.
If you consider this tactical move, an exchange-traded fund would be a good way to implement it — two to consider are iShares Russell 2000 index (ticker: IWM) or iShares S&P SmallCap 600 index (IJR).
A note of caution: When it comes to tactical moves, you have to think about income tax costs and transaction costs that may diminish your results. Tactical moves work better if they can be made in tax- deferred accounts, such as an IRA. If you are uncertain, consult with your tax advisor before making any such move.
Disclosure: Bob Phillips and the firm’s clients are not invested in iShares Russell 2000 Index or iShares S&P SmallCap 600 index.
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It’s the ‘Good Season’ for the Stock Market originally appeared on usnews.com
