The Best Six Months is basically the flipside of the old “sell in May and go away” adage. That phrase comes from an old British saw, “Sell in May and go away, come back on St. Leger Day.” Established in 1776, the St. Leger Stakes is the last flat thoroughbred horserace of the year and the final leg of the English Triple Crown. Apparently, once the British horseracing season concludes everyone can get back to the business of buying stocks.
While the St. Leger Stakes has little to do with stock market seasonality, it does coincide with the end of the worst months of the year for stocks. Market seasonality is a reflection of cultural behavior. Back when farming was the big driver of the U.S. economy, August was the best market month. Now that farming makes up less than 2% of the U.S. economy it’s one of the worst, as it falls during a time when traders and investors prefer the golf course, beach, or pool to the trading floor or computer screen. Institutions’ efforts in the fourth quarter to beef up their numbers can help drive the market higher, as does holiday shopping and an influx of year-end bonus money. This is followed by the New Year, which can tend to bring a positive “new-leaf” mentality to forecasts and predictions and the anticipation of strong fourth- and first-quarter earnings and drives the market higher into the second quarter.
Trading volume can decline throughout the summer and then in September there’s back-to-school, back-to-work, and end-of-third-quarter portfolio window dressing that has caused stocks to sell off in September, making it the worst month of the year on average. Although there may be some shifts in seasonality, the record still shows the clear existence of seasonal trends in the stock market.
The best six months delivers
Investing in the Dow Jones Industrial Average between November 1st and April 30th each year and then switching into fixed income for the other six months has produced reliable returns with reduced risk since 1950. Exogenous factors and cultural shifts must be considered. “Backward” tests that go back to 1925 or even 1896 and conclude that the pattern does not work are best ignored, as they do not take into account these factors. Farming made August the best month from 1900-1951, but since 1987 it is the second worst month of the year for Dow and S&P. Panic caused by financial crisis in 2007-08 caused every asset class aside from U.S. Treasuries to decline substantially, but the bulk of the major decline in equities that occurred during the worst months of 2008 was sidestepped using this strategy.
Figure 1 reveals that November, December, January, March, and April have been the top months since 1950. If you add in February, you have an impressive six consecutive month trading strategy. These six consecutive months gained 14,654.27 Dow points in 62 years, up 48 and down 14. May through October months lost 1,654.97 points, up 37 times and down 25.
David Aronson, author of Evidence-Based Technical Analysis (Wiley 2006), and his colleague Dr. Timothy Masters back-tested the Best Six Months Switching Strategy using their scientific method from 1987 (one year after the strategy was published in the 1986 Stock Trader’s Almanac) to April 2006. They found that from 1987 through April 2006 the S&P 500 generated an annualized return of 16.3% during the Best Six Months compared to 3.9% for the Worst Six Months. Though no back-test can predict future results, in Aronson and Masters' opinion the Six-Month Switching Strategy was sound, valuable, and had predictive power. The returns were considered to be statistically significant, unlike any of the 6,402 rules tested for the book.
1950s seasonality reversal
Figure 2 shows the one-year seasonal pattern of the Dow Jones Industrial Average over three timeframes since 1901. By examining this comparison of the Dow’s seasonal pattern during the first half of the Twentieth Century to the pattern since 1950 a major reversal in market seasonality is quite clear. In fact, before 1950 the better strategy appears to be “Buy in May,” the polar opposite of the present day. The 25-year period since 1988 illustrates that the Best Six Months/Worst Six Months pattern endures. On average the market rises from a low in October to a high in May, and then drifts sideways to lower from May to October.
Doing the math, the November-April $674,073 gain overshadows May-October’s $1,024 loss. Just three November-April losses entered double digits:
- April 1970: Cambodian invasion
- 1973: OPEC oil embargo
- 2008: Financial crisis
Similarly, Iraq muted the Best Six and inflated the Worst Six in 2003. When we discovered this strategy in 1986, November-April outperformed May-October by $88,163 to minus $1,522. Results improved substantially these past 26 years, $585,910 to $498.
Figure 3 shows the percentage changes for the Dow Jones Industrial Average along with a compounding $10,000 investment during the Best Six Months November-April versus the Worst Six Months May-October. It is hard to miss the market’s tendency to be flat to down from May through October, while posting most of its gains from November through April.
Timing is on our side
Using the simple Moving Average Convergence Divergence (MACD) indicator developed by Gerald Appel to better time entries and exits into and out of the Best Six Months period nearly triples its cumulative results since 1950. In up-trending markets, MACD signals get you in earlier and keep you in longer. If the market is trending down, however, entries are delayed until the market turns up and exit points can come a month earlier. Beginning October 1, you might look to catch the market’s first hint of an uptrend after the summer doldrums; beginning April 1, considering preparing to exit seasonal positions as soon as the market falters.
The results are astounding. Instead of $10,000 gaining $674,073 over the 63 recent years when invested only during the Best Six Months, the gain nearly tripled to $1,878,557. The $1,024 loss during the worst six months expanded to a loss of $6,723. Impressive results for being invested during only 6.3 months of the year on average.
|MACD||Worst 6 Months||MACD||Best 6 Months||Buy & Hold|
|Date||DIJA||% Change||10,000||Date||DIJA||% Change||10,000||Year||% Change||10,000|
|63-Year Gain (Loss)||(6,714)||$1,878,516||$644,751|
* MACD generated entry and exit points (earlier or later) can lengthen or shorten six month periods.
Putting the strategy to work
A more conservative way to execute this switching strategy, which I call the in-or-out approach, entails switching capital between stocks and bonds.
During the “Best Months” an investor or trader is fully invested in stocks. One inexpensive way to gain stock market exposure is through index-tracking ETFs and mutual funds. During the Worst Months you could then switch into Treasury bonds, money market funds, or a bear/short fund. Money market funds may be most conservative, but are likely to offer the smallest return. Bear/short funds offer potentially greater returns, but more risk. If the market moves sideways or higher during the Worst Months, a bear/short fund is likely to lose money. Treasuries can offer a combination of decent returns with limited risk.
In my opinion, this approach can work well for retirement accounts where the goal is to build wealth over time. Of further benefit, you will probably find summertime vacations and activities much more enjoyable because you will not be concerned with stock market gyrations while your nest egg is parked in cash or bonds. Since 1950, there have only been 9 years when the DJIA Best Six Months failed to delivery market gains.
Another approach to take advantage of this switching strategy involves making adjustments to your portfolio in a more calculated manner. During the Best Months additional risk can be taken as market gains are expected, but during the Worst Months risk needs to be reduced, but not entirely eliminated. There have been several strong “Worst Months” periods over the past decade, including 2003 and 2009. Taking this approach is similar to the in-or-out approach, however; instead of exiting all stock positions a defensive posture is taken. Weak or underperforming positions should be closed out, stop losses raised, new buying should be limited, and a hedging plan put in place. Purchasing out-of-the-money index puts, adding bond market exposure, or taking a position in a bear market fund could mitigate portfolio losses in the event a mild summer pullback manifests into something more severe such as a full-blown bear market.
JEFFREY A. HIRSCH is editor-in-chief of the StockTradersAlmanac.com and the author of The Little Book of Stock Market Cycles (Wiley, 2012). He is Chief Market Strategist of the Magnet AE Fund.