From Bearun's -
(and don't forget to change the settings in your
charting programs <g>)
September 6, 1999
Seasons in the Sun
The stock market has them and -- surprise! -- they can be timed
By Sy Harding
Random-walk theorists tell us the market meanders randomly
and can't be timed. Efficient-market theorists claim that all the
information that will affect the market is instantly in stock prices.
Wall Street warns investors not to try to time the market. "It
can't be done," the naysayers assert. If they're right, the only
alternative, other than avoiding the stock market altogether, is to
buy and hold. But for the buy-and-hold theory to work, two
things must happen.
First, the investor's specific holdings, not "the market" --
meaning the major indexes -- must do well over the long haul,
bouncing back from any bear markets. However, many stocks
popular in one bull market are pariahs in the next.
It's worth noting that the issues
in the very indexes used to gauge
the market's performance are
constantly changing. For
example, 30% of the stocks that
were in the Dow Industrials
when they topped out in 1987
are no longer in that benchmark
average. They were replaced, a
few at a time, by stocks of
newer, stronger companies more attuned to the changing
economy. And almost 60% of the companies that were in the
S&P 500 20 years ago are gone, because they were bought by,
or merged into, others or because they failed or their stocks fell
dismally out of favor.
If even blue chips in the indexes can't always be depended upon
to recover, is the idea that "the market always come back" really
meaningful to individual investors?
For the buy-and-hold theory to work, investors also must
emerge from the other side of bear markets still holding the
stocks they entered them with. There's no evidence of that ever
happening on a wide scale in the past, and it's not likely to occur
today.
Some intrepid U.S. investors who jumped into the Japanese
market in late 1989, attracted by that nation's then-powerful
economy and booming stock market, may have held through its
initial 65% plunge, but they certainly didn't continue to hold
through the 1990s. If they had, they'd still be miserable; the
Nikkei remains more than 50% below its bull market peak of
1989.
Closer to home, how many investors have patiently waited for
underperforming value and small-cap mutual funds to come
back? Judging by the huge flow of money out of such funds and
into index funds, not many.
A buy-and-hold strategy guarantees that a person will suffer not
only the next bear market, but every bear market in his investing
lifetime. Not much fun, considering that, over the past 100
years, by my count, there have been 22, each lasting, on
average, 15 months and bringing declines of 36.3%.
But there's another way to play the game: Timing the market
through a simple strategy that has produced sparkling results.
Two simple observations underpin my concept:
First, the market tends to make most of its gains between
November and May each year, and then usually enters the
doldrums between May and November. Why? Because
investors receive extra cash between November and May --
from sources such as year-end bonuses and distributions,
corporate contributions to profit-sharing plans and income-tax
refunds. Much of this flows into stocks, driving prices higher.
When the extra dollars stop pouring in, Wall Street slows down
until the following October, when the cycle begins again.
Second, the market tends to be positive from the last trading day
of each month through the fourth trading day of the following
one. This also seems linked to cash-flow bulges, as many
high-income folks receive their paychecks monthly, rather than
weekly.
Combined, the two patterns cry out: "Enter the market on the
next-to-last trading day of every October, and exit to cash on the
fourth trading day each May."
Since 1964, had an investor followed this simple mechanical
procedure, his performance almost would have doubled the
Dow's. Furthermore, the seasonal investor would have done this
with half the risk, since he would be exposed to the market only
six months each year.
But this is only part of the story.
Obviously, rallies aren't going to begin exactly on the next-to-last
trading day of every October. And they won't all end on the
fourth trading day of every May. So, I added a simple
short-term indicator called MACD (Moving
Average/Convergence Divergence), to better pinpoint profitable
entry and exit points as the calendar dates approached.
MACD, developed by market timer Gerald Appel, signals when
market momentum has reversed direction. It is calculated by
subtracting a 26-day exponential moving average of the Dow's
daily closes from a 12-day exponential moving average of the
closes.
The result is plotted against a 9-day moving average of the
closes.
A buy signal is triggered when the main MACD indicator line
breaks up through the 9-day moving average. A sell signal occurs
when the indicator line breaks down through the 9-day line.
The addition of that simple technical indicator, frequently found
in investment software packages, enhanced the Seasonal Timing
Strategy significantly. Now when I back-tested it over the past
35 years, its performance tripled that of the Dow. (Market
historian Yale Hirsch recently back-tested my strategy against
the S&P 500 over the past 50 years, with similar results.)
The idea is to simply ignore all MACD signals through the year
except when close to a planned calendar entry or exit date. Then
if it triggers a buy signal two or three weeks prior to the calendar
date, enter immediately rather than waiting. If it's still on a
short-term sell signal when the calendar date arrives, wait until it
reverses to a buy signal before entering. I use it in the opposite
manner as the May exit date approaches.
The Seasonal Timing Strategy has a good record in telling investors when to get in
and out of the market, as shown by the arrows on the chart. In part, it is based on
observations that the stock market usually is at its strongest from November
through May and from the last trading day of each month through the fourth trading
day of the following month.
As the chart shows, the seasonal timing strategy has worked
very, very well in recent years. It easily outpaced buy and hold,
in part by avoiding the minor corrections of 1997 and 1998.
Buy-and-holders needed part of the gains in the subsequent
favorable seasonal periods just to get back to even.
Don't forget that following this strategy also allows an investor to
collect cash for six months every year, via interest and
dividends. The only downside: It also can subject investors to
short-term capital-gains taxes.
Using the Seasonal Timing Strategy would have kept investors
out of the 1987 crash and the 1990 bear market, both of which
took place during the unfavorable May-November stretch. It
even would have helped them avoid the Great Crash of 1929.
Right now, the timing strategy has me out of the market, and I
won't know whether I'll get back in until the end of October
nears. Will the strategy continue to work? It certainly should. It
just might be more important to be a seasonal investor than a
seasoned one.
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