September has arrived. For market participants it is not only the time to return to their offices after summer vacation, but also the time to experience a great deal of anxiety. Many investors know perfectly well that September is the worst month for financial markets in terms of performance (see Picture 1 below). Some investors are familiar with the expression, “Sell in May and Go Away“. Most investors have also heard of the Christmas rally in November and December too.
Still, there is no unambiguous rational explanation for all these recurring calendar anomalies. Perhaps people are reducing their exposure to stocks in May before the start of the summer holiday season. Who wants to constantly check stock quotes while lying on the beach? Probably the end of the summer holiday season in September, less sun, and more rain are the reasons why many investors experience episodes of sadness, worry or even outright depression. At the same time, Christmas preparations and New Year’s resolutions are likely to improve your mood and boost your optimism.
Anyway, for those who are looking for the opportunity to know the future by relying on numbers, there are both encouraging and discouraging statistics.
The encouraging statistics say that the probabilities that the stock market will rise in any given year range from around 70% to more than 80% (see Picture 2 below).
The discouraging statistics, however, show that the stock market return may fluctuate in a very wide range in different years: from a fall of more than 40% to a rise of more than 50% (see Picture 3 below).
The discouraging statistics also demonstrate it may take five to six years for the stock market to fully recover after the onset of a bear market, when a broad market index falls by 20% or more from its most recent high (see Picture 4 below).
Still, the encouraging statistics reveal that if you hold your “average market portfolio” for more than 5 years, the probability of positive portfolio performance will reach 80% (see Picture 5 below).
If you have a flair for number-crunching, then you will certainly enjoy reading the Stock Trader’s Almanac and similar publications. For example, one of this almanac’s favorite statistics is the “January Trifecta” (see [ 1 ] below). It is based on the Santa Claus rally, the New Year’s Post-Holiday rally, and the January Barometer. The Santa Claus rally reflects the stock market’s direction in the last five trading days of the outgoing year and the first two trading days of the new year. The New Year’s Post-Holiday rally shows the market performance in the first five trading days of the new year. On the other hand, the January Barometer represents the market return during the first month of the new year.
Historically, when all the three gauges were up, the Standard & Poor’s 500 Index performance for the remainder of the year has risen 90% of the time with an average gain of 17.5%. When any of the indicators were down, the stock market performance for the remainder of the year were also reduced. When all the three gauges were down, the Standard & Poor’s 500 Index fell three out of eight years with an average loss of 3.6%.
In 2022, the Santa Claus rally has produced a positive return of 1.0%, while the New Year’s Post-Holiday rally has generated a negative return of -1.9%, and the January Barometer has been decidedly negative with a return of -5.3%. Thus, the statistical “stars” were predicting a rather difficult year ahead for the stock market in 2022. So far, this prediction has turned out to be pretty accurate with the Standard & Poor’s 500 Index falling by 17.0% by the end of August.
Can non-professional investors practically use this information to support their investment decision process?
First, do not overestimate the predictive power of statistical “stars”. All statistical relationships become more significant and stable with longer periods of record. That is why in any given year financial market developments may contradict much of what the “statistical horoscope” predicted.
Second, if you are an active investor and follow short-term trends, then you can take these statistics into account because they show you the probabilities of financial market developments based on some historical data. However, since these probabilities become practically relevant only when there is a large set of historical data, it would be wise to open a statistics-based trade only when it is accompanied by a stop-loss order to limit your potential loss.
Third, if you are a long-term investor, these statistics can be used to rebalance your investment portfolio. For example, if you regularly add new funds to your investment portfolio on an annual basis, then this can be done following the “traditional” May or September market corrections, when it is highly likely that stock prices will fall, according to the statistics discussed above. If you need to withdraw some funds from your investment portfolio, then this can be done at the end of the “traditional” Christmas rally, when it is very probable that a rise in stock prices will be substantially above average.
Fourth, you should maintain your investment discipline. We are biological beings, and our decisions are the result of both rational analysis and emotional factors. That is why following your investment strategy is more important than any statistics.
Economy is the mixture of mathematical relationships and psychosocial variables, while financial markets are our attempt to discern the economy of the future. As a result, in the long term, financial markets behave mostly mathematically and rationally. At the same time, in the short term, they are emotional and psychologically difficult to predict, thus reflecting our human nature. Know yourself, and success will follow!
References:
[ 1 ] “Trio of Indicators Set to Give Wall Street Clues for 2022”, Jessica Menton, Bloomberg News, 3 January 2022.
