Personal Finance : Portfolio Manager's Toolbox
To Everything There Is a Season: A Look at Calendar Effects
By David Edwards
Special to TheStreet.com
11/23/00 8:29 AM ET
In my Aug. 31 column, Take Tax Losses Now, Avoid the Year-End Rush, I urged investors to take tax losses in September rather than wait until the end of the year. Mutual funds have a well-known propensity to realize losses in October in advance of the Oct. 31 fiscal year-end for most mutual funds. This year, tax-loss harvesting was particularly aggressive by fund managers looking to avoid handing their investors capital gains in a year in which most funds are likely to generate negative returns.
The knowledge that stocks or the stock market are going to behave in a certain way at a particular point in the year is known as a calendar effect. And there are other calendar effects investors can profit from.
Earnings Reporting Cycle
Most companies release earnings in January, April, July and October. Companies that anticipate shortfalls are mostly likely to preannounce during preceding months, which is to say, December, March, June and September. These preannouncements tend to depress stock prices as investors worry whether bad news at Lucent (LU:NYSE - news), for example, means bad news for other telecom equipment managers.
There tends to be very few surprises during the regular earnings reports, so stocks rally in those months. At my money-management firm, we let cash accumulate in our clients' accounts until just before regular earnings reports are released, then invest 100%.
Historically, September has been the worst month of the year. By September, analysts can see which companies aren't likely to make their full-year numbers and issue downgrades accordingly. In recent years, the booming economy obviated the necessity for wholesale downgrades, but this year we're seeing quite a slew of analyst markdowns.
Part of the "January effect" can be attributed to analysts closing the door on last year's analysis by issuing bullish projections for the year to come.
End-of-Week and End-of-Month
In recent years, we've noticed the markets slumping Friday afternoon from 1 p.m. ET on, regardless of the trend earlier in the day. We attribute this to market makers and daytraders, who are getting out of long positions in stocks before the weekend. The markets tend to rally Monday morning as short-term traders re-establish positions.
So, if we're going to invest new money, we wait through the weekend to take advantage of the Monday rally. Over the past 10 years, the net gain in stocks on Mondays (or Tuesdays, after a three-day weekend) is greater than the other four days of the week put together.
The stock market tends to rally the last few days of each month, then fall off as the new month commences. Part of this pattern has to do with portfolio managers "marking up" positions at reporting periods with some timely trades. The bigger effect has to with the timing of cash flows from investing institutions -- banks and insurance companies tend to sweep cash balances once a month to their money managers. So month-end prices rise as the new cash is invested and slump back a few days later.
In recent years, a second midmonth cash flow pushes up returns during the second week of the month. As a majority of Americans now have automatic 401(k) contributions, there's a wave of fresh cash coming out of bimonthly paychecks. If you have an automatic deposit into your brokerage account, change the timing to the first or third week of each month for a little extra return.
Watch the Fourth Quarter
Investing in the fourth quarter requires extra vigilance. On one hand, November, December and January tend to be the strongest three months of the year due to a combination of the end of tax-loss sales, new money coming to work in January and analyst upgrades. But three of the largest market declines (1929, 1987, 1997) came in October. Overall volatility seems to increase in the fourth quarter commensurate with the increase of uncertainty about corporate prospects, tax-loss harvesting, money flows -- and this seems particularly relevant -- the outcome of elections.
If you keep your capital intact through the first part of the fourth quarter, investing in the second half (by Dec. 15) can be particularly profitable. Historically, the gains in the market from November through April vastly outstrip the gains in stocks from May through October. Economic activity dips during the summer months (worker productivity declines as more people take vacations; many companies, such as car manufacturers, shut down plants for retooling) but we also think investors mentally "check out" at that time of the year and come back in the fall.
Strategy
Can you make money blindly buying and shorting stock market futures based on calendar effects? No, the extra percent return here and there gets eaten up by trading costs and commissions. Also, you have to remember that exogenous effects (things no investor thought of, such as the current mess in the Electoral College, the collapse of emerging-market debt in 1998, the invasion of Kuwait by Iraq in 1990) overpower calendar effects.
You can, however, increase your overall returns, as we do, by timing your new investments to those periods most favorable for stocks. We let new cash accumulate in our client accounts from August until the end of October (avoiding the summer slump, tax-loss harvesting, analyst downgrades and corporate preannouncements.
This year, we invested the new accounts right before Halloween, anticipating the conclusion of the presidential election and a nice year-end rally from relatively depressed levels. Obviously, we got thumped over the past three weeks with lack of closure on the election. But we expect quite a good rally when the new president is finally named. Calendar effects have been exhaustively documented by stock market newsletter writer Yale Hirsch. His firm produces the annual Stock Trader's Almanac. The 2001 edition is available at www.2001stockalmanac.com. |
