Last month we discussed the September Effect and how the market seemingly declines every September due to cyclical market trends. Sure enough, the S&P 500 declined 4.8% in September of this year, which, according to S&P Global, marked the 53rd time since 1928 that the S&P was negative in September.
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The rock band Green Day sings, “Wake me up when September ends,” and that is likely how most investors felt the last week of September when the S&P fell more than 6.5% off its September highs. But as we turn the calendar to the fourth quarter of the year and the weather gets colder, the market historically tends to heat up. As mentioned before, the market is very cyclical and trend heavy. Some of these trends are rooted in statistical significance, while others are based on traditional vacation calendars, but they all play a part in the market and investing calendar. Take, for instance, the aforementioned September Effect, the Santa Claus Rally, and the stock market indicator tied to February’s big football game. But what about the Halloween Strategy?
The Halloween Strategy is simply a market-timing strategy based upon investing in stocks from Oct. 31 to May 1, and then shifting to more defensive allocations during the summer months until the following Halloween. This trend also goes by another moniker, widely known as “Sell in May and go away.” An investor that adheres to the Halloween Strategy would also, by the transitive property, be following the previously mentioned market trends:
- Invest at the end of October.
- Experience the joy of the holiday season with the Santa Claus Rally.
- Watch the big game in February, while rooting hard for the NFC team to win so that the S&P 500 will end the year positively.
- Shift to a more defensive position in May to “go away” until the cycle repeats.
There are many theories as to why the strategy exists. As we covered with the September Effect, many mutual funds and other institutional investments are built to end their fiscal years in September and exit positions in the portfolio that were at a loss. That downward selling pressure in the market may then create a short-term buying opportunity from the dip, causing prices to rebound in early to middle Q4. Another idea is that Q4 is generally a higher spending quarter for consumers due to the holidays and festivities through the end of the year. Halloween, Thanksgiving, and the December holidays create reasons to travel, buy gifts and generally spend money. Companies that stock up on inventory throughout the year generally see strong Q4 numbers because of holiday spending, which boosts consumer sentiment, earnings and the market.
With every trend or idea, the most important part of the experiment comes with testing the thesis. Does the Halloween Strategy work and provide statistical outperformance over an extended time horizon?
On the surface, the answer appears to be an overwhelming yes. According to Mark Hulbert’s Hulbert Ratings, the six-month period between Halloween and April 30 has outperformed the following six months of the year by over 3% annually since 1896. However, when years are broken out into one of two categories – midterm election years and non-midterm election years – the results paint a different picture. Over the same period, it can be observed that during midterm election years, the average winter return is 10.4%, compared to 0.8% for the summer return. In the other three years of a presidential cycle, the winter months have outperformed the summer months 3.6% vs 2.6%, respectively.
According to a study from the Journal of Financial Economics, titled “Asset Prices, midterm elections, and political uncertainty,” the discrepancy in returns during a midterm election year is due to investors’ aversion to uncertainty. In the months leading up to an election, there is an influx of economic uncertainty. Once elections are over, that uncertainty subsides, and the market subsequently reacts.
Because we are not in a midterm year is not cause for concern that the markets will fall this winter, but rather a suggestion to validate any seasonal bullishness with other trends or signals.
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