On distribution... and the much misunderstood "Seasonality Factor"
It is widely recognized that stocks have just entered a seasonally favorable November-April period. Indeed, this is so widely recognized that one might wonder whether investors have not already exhausted the upside potential by positioning themselves in advance. In this case, who will provide the buying interest to fuel a follow-through?
That question aside, if we assume that the November-April period will be as favorable as it has been in the past, shouldn't we abandon our defensive stance and move to a bullish position? One of the benefits of having an objective approach is that we can obtain exact answers to these questions. On this one, the answer is that a defensive position remains appropriate, regardless of seasonality.
Since 1945, the November-April holding period has generated annualized total returns in the S&P 500 of 18.4%. This contrasts with a substantially smaller 7.4% average return for the May-October holding period.
In addition to seasonality, however, we can partition history based on which Market Climate was in effect at any given time. When we do that, we get substantially more insight.
Specifically, when we restrict the analysis to periods during the favorable November-April span when trend uniformity was also favorable, the annualized return for the S&P 500 averages 27.8%. But during November-April periods when trend uniformity was unfavorable, the average annualized return whittles down to just 0.2%. If we further restrict those seasonally favorable periods to points when both valuations and trend uniformity were unfavorable (as they are now), the S&P 500 has averaged an annualized loss of -6.6%.
Similar patterns hold true for unfavorable seasonal periods.
In other words, historical returns have displayed a seasonal pattern favoring the November-April period. But the influence of seasonality never reverses the implications of the prevailing Market Climate. It is not favorable seasonality that we wait for - it is a favorable Market Climate.
For now, the Market Climate in stocks remains unfavorable. The Market Climate in bonds remains modestly constructive. We are positioned accordingly.
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