Seasons in the Sun strategy: Market Folklore Under the Microscope

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Market Folklore Under the Microscope:
Does 'Seasonal Investing' Really Work?

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Market Folklore Under the Microscope:
Does 'Seasonal Investing' Really Work?

At Schwab, we believe in disciplined, long-term investing, not in "hot tips," chasing after the market's latest trends or staking your future on your ability to accurately predict short-term market movements. In other words, we believe in facts, not hype, prudent diversification and taking a long-term view.

That's why we closely examine any market myths that could otherwise keep investors from reaching their long-term goals. A surprisingly long-lived bit of market folklore, for example, contends that the stock market has a tendency to fall into the doldrums over the summer months. In fact, some investors subscribe to the saying "sell in May and go away," in the belief that the market usually performs better from November through April than from May through October.

But are market returns over the summer months truly weaker than those at other times of the year? And does "seasonal investing" really pay off?

Monthly Trends
The Schwab Center for Investment Research® (SCIR) set out to find an answer to these questions. SCIR analysts began by analyzing the individual monthly returns of the S&P 500® Index (a common proxy for the overall stock market) since May 1926.

What SCIR researchers found may seem surprising. They discovered that the S&P 500 Index actually tended to produce higher average returns in July than in any other month of the year, including the winter months, (see the chart above.) The Index's average returns for the months of June and August were also quite healthy. At the other end of the spectrum were September, the only month in which the S&P 500 averaged a negative return, and October, in which the Index tended to post weak returns more frequently than in other months.

The conclusion? For one thing, investors who had followed through on the saying "sell in May and go away" would have missed strong returns in many a June, July and August over the years.

Does Seasonal Investing Really Work?
SCIR researchers then considered whether "seasonal" investing made sense in any year. To do so, they calculated the results an investor would have achieved by investing in the S&P 500 Index from November through April ("winter"), then retreating to cash (as represented by 30-day Treasury bills) from May through October ("summer"). Once again, SCIR researchers used data from May 1926 to April 2002 to ensure that the findings would be as comprehensive as possible.

Interestingly enough, SCIR researchers found that the S&P 500's average monthly return was indeed higher (1.2%) for the November to April period and lower (0.8%) for the May to October period. Looked at with a critical eye, however, these findings still do not make a compelling case for seasonal investing. Why? Because the alternatives to accepting slightly lower equity returns during the summer have generally not been attractive. Putting investment dollars into cash in the summer months, for example, would have led to even lower average monthly returns (.32%) than those that could be achieved in the stock market over the same period.

Largely as a result, SCIR concluded that a "seasonal" strategy - winter in the stock market, summer out - has not proven to be very successful. The study found that a portfolio that remained fully invested in the S&P 500 outperformed a "seasonal" portfolio more than half the time. To further test this, every one-, three-, and five-year period since 1926 was analyzed and the results remained consistent, regardless of the holding period.

In fact, SCIR found that $10,000 invested in the S&P 500 Index starting in May 1926 would have grown to more than $23 million by April 2002. The same $10,000 invested in May 1926 according to a seasonal plan - that is, invested in stocks from November through April, then placed in cash from May through October - would have grown to only $5.7 million by April 2002.

Lessons for Investors
The SCIR study of seasonal investing proves once again that time in the market is much more important than timing the market. Moreover, a seasonal strategy is likely to look even less competitive once the transaction costs and tax consequences of frequent trading are factored into the equation. The lesson? A disciplined strategy of investing in the stock market probably offers a better chance of helping you meet your long-term goals than any so-called "seasonal" market-timing strategy ever could.

The content of this article is intended for education purposes and should not be considered investment advice or a recommendation to buy or sell securities. Past performance is no guarantee of future results. Investing strategies cannot protect against a loss in a declining market. Indices are unmanaged, do not incur fees and cannot be invested in directly by an individual.

SCIR is an affiliate of Charles Schwab & Co., Inc.

-- posted by Kirk