What does seasonal investing include?
By definition, seasonal investing includes:
A seasonality study preferably uses at least 10 years of data. Most of our studies use 15-20 years of data However, data may not always be available for 10 years. Studies using less than ten years of data can be used, but they tend to be less reliable. Results of shorter term studies have a higher chance of being skewed by a single data point.
Results using at
least ten year of data tend to be stable for long periods of time,
particularly when annual recurring fundamental reasons causing seasonality are
unchanged. However, “statistical” slippage can occur. For example, the
Time length for intermediate periods of seasonal strength or weakness ranges from five weeks to seven months. In addition, special short term periods often related to holidays have been identified. Examples include strength just before and after U.S. Thanksgiving and strength from just before Christmas until just after the New Year. Also, longer term “cyclical” periods lasting several years have been identified. Most notable is the four year economic or “presidential” cycle. Data for longer term cyclical periods frequently can be overlaid with annual data to refine seasonal entry and exit points.
Some sectors and commodities have more than one period of seasonal strength. A good example is the Canadian financial services sector. Its periods of seasonal strength are from the end of September to the end of December and from the end of February to the end of May. Investors frequently will combine the two periods. Traders with a shorter time horizon may choose one or both periods based on fundamental and technical considerations.
Most periods of seasonal strength are NOT followed by a periods of seasonal weakness. In most cases, periods of seasonal strength are followed by a period of random performance. Markets moving from a period of seasonal strength to a period of seasonal weakness are rare.
Seasonality is measured in three ways:
A seasonal investment by definition is profitable more than 50% of the time. If frequency of profitable trades is 50% and frequency of unprofitable trades is 50%, results are random. Confidence in a seasonal trade increases with the frequency of profitable trades. A confidence level for a seasonal trade exceeding is 70% is preferred. A confidence level of 80% frequently is available. A confidence level of 90% is relatively rare. A confidence level of 100% is extremely rare.
Primary Factors Influencing Seasonality
Seasonality happens because of a series of annual recurring events. The job of a seasonality analyst is to examine if the annual events are likely to recur prior to a period of seasonal strength. If annual recurring events are less likely to occur, the seasonality analyst will avoid recommending a seasonal trade.
The classic example
is a series of recurring events that trigger the annual period of seasonal strength
in the Canadian equity market. The
TSX Composite Index has an historic period of seasonal strength from the end of
September to the end of April. The strategy is known as the “Buy when it snows,
sell when it goes” strategy: Canadian equity markets historically start to move
higher near the end of September when the first snowfalls frequently appear in
many parts of southern
Securities Suitable for Seasonal Equity Investing
Security suitability depends on the knowledge level achieved by the investor:
Investors with the least amount of investment knowledge should focus on Exchange Traded Funds (ETF) that track the seasonality of well known equity indices and sectors. A wide variety of ETFs currently are available. Over 800 equity ETFs currently are listed on North American exchanges. ETFs hold a basket of equities that track an index. Reasons to own ETFs include their diversification, low cost, tax efficiency and ease to buy and sell. Better known Exchange Traded Funds include DIAMONDS (i.e. Dow Jones Industrial Average tracking units), SPYDRS (i.e. S&P 500 Index Deposit Receipts), Qubes (i.e. NASDAQ 100 tracking units) and i60s (i.e. TSX 60 Index units).
Investors with access to reliable fundamental analysis sources can choose individual equity securities that track a period of seasonal strength. Top choices are individual equities with encouraging news making potential during the period of seasonal strength.
Similarly, investors with access to reliable technical analysis sources can choose individual equity securities that are developing favourable technical patterns during a period of seasonal strength.
Investors with greater investment knowledge can apply sophisticated strategies including various conservative listed option strategies that tie into periods of seasonal strength.
Combining Seasonality with Technical and Fundamental Analysis
Using seasonality as a “stand alone” tool to make investment decisions is NOT recommended. Seasonality is a useful analytical tool, but only when used in conjunction with fundamental and technical analysis. Trades based on seasonality alone are profitable in say seven or eight times out of 10, but are unprofitable in two or three times out of ten.
The same can be said for investment based on technical analysis. Reliable technical patterns such as head-and-shoulders patterns are accurate approximately 75% of the time. However, they are not accurate 25% of the time.
Trades based on
fundamental analysis alone also are not recommended. Fundamental analyst
picks may be profitable most of the time. However, results from a stock picking
contest during 2006 run by the Globe and Mail showed that even the best
fundamental analysts are far from perfect. The contest requested each
participant to choose one stock to buy at the beginning of 2006 and to hold
until the end of the year. Participants included a college student, a financial
journalist and seven of
Chances of a choosing a profitable seasonal trade are greatly enhanced if all three methods of analysis are combined. Of equal importance, chances of losing capital are greatly reduced.
Seasonality analysis is the bridge between fundamental and technical analysis:
Identifying Seasonal Trades
Several methods are available to identify periods of seasonal strength:
One of the greatest
myths on Wall Street and
Another myth is the
expression “Sell in May and go away”. The myth originated from an actual
period of seasonal strength in the base metal sector. Base metal prices as well
as base metal equity prices tended to peak early in May and bottom near the end
of September. The main reason was the annual operating shut down by base metal
smelters in Europe in July and August for
April, performance in the May to September period is random. This period does not have a sufficient number of annual recurring events to influence equity markets.
Another myth is that the month of October is a weak and dangerous month for North American equity markets. The myth is based on the fact that substantial downdrafts in North American prices have occurred in the month of October. October 1929 and October 1987 are seared into the minds of traders. However, data during the past ten years suggests that fears of weakness in October no longer are founded. The S&P 500 Index has advanced in five of the past 10 periods and the TSX Composite Index has gained in seven of the past 10 periods. On the contrary! October frequently is the month of the year when important seasonal lows frequently are reached.
Identified Periods of Seasonal Strength for Equity Indices, Equity Sectors, Industrial Commodities and Selected Stocks as of June 1st 2009
Lots of changes this year due to the big downdraft in equity markets during the past year! Most seasonal trades showed diminished returns based on data for the past 10 years. In addition, some seasonal trades experienced slippage (e.g. data showing that the optimal period for entering a seasonal trade moved from September to October). Seasonal trades that generated an average return of 5% were eliminated. New seasonal trades were added (e.g. Gold equities, Platinum). Following is the annual report:
Exchange Traded Funds are available on all of the above sectors.
Following is seasonality for equivalent Canadian sectors:
** Exchange Traded Funds are available.
** Exchange Traded Fund available
** Exchange Traded Fund or Note available
Selected Periods of Seasonal Strength in Sectors Based On Identified Annual Recurring Events
· Key health care conferences usually are in September (Oncology conference) and January (JP Morgan health conference). The sector has a history of reaching a seasonal peak when the JP Morgan health care conference is held in mid January.
A higher frequency of drug approval in the
· Strength in the July to September period corresponds to strength in gold. Gold strengthens when gold fabricators are buying gold to make jewelry for the Christmas and Dhaliwal seasons.
· Gold stocks and ETFs tend to be contra-cyclical. They move higher during periods of stock market weakness (particularly in summer months).