For many, October brings cooler weather, autumn colors, and, of course, Halloween. October’s end can also signal the best time of year to invest in stocks, according to the so-called Halloween Indicator.
Is now the time to buy? Not necessarily, as there are a multitude of reasons you should not invest solely based on historical price patterns. First and foremost, any decision you make should be made within the context of your specific investing strategy. Moreover, earnings, economic factors, and other fundamentals drive stock prices over the long term, rather than seasonal trends.
However, if you like looking for trends to invest, in part, based on momentum, you might consider seasonal patterns like the Halloween Indicator. This pattern suggests that, on average, investors historically tend to find stocks a good treat over the next six months.
The Halloween Indicator
Also known as the “best six months,” the Halloween Indicator is essentially the flip side of the “Sell in May and go away” strategy. Both seasonal patterns are based on the finding that the historical average performance for the November through April period outperforms the May through October time frame. Since 1928, the S&P 500® Index has gained, on average, 5.1% from November through April, while adding just 1.9% from May through October.1
However, returns have varied widely from year to year. You need look no further than this past year: The S&P 500® Index lost more than 1% from November 1, 2015, to April 30, 2016, and has gained nearly 5% since the beginning of May 2016, as of late-October (see chart below).
Additionally, history shows that for both the short- and long-term investor, there may be better strategies than simply selling stock positions in May and buying them back in November.
For example, S&P Capital IQ looked at five different strategies using data over the past 25 years to compare the impact of different combinations of investments—based on the best six months pattern (see chart and table below). All strategies involved investing in stocks from November 1 to April 30, and then taking different actions from May 1 to October 31. Those five strategies S&P Capital IQ considered are:
- Stay invested—earning the S&P 500® Index total return
- Cash—selling stock positions and earning the three-month T-bill return
- Bonds—earning the Barclays Aggregate Bond Index return
- Low-volatility stocks—earning the S&P 500® Low Volatility Index return
- Sectors—purchasing a portfolio of 50% consumer staples and 50% health care
In analyzing these five strategies, S&P Capital IQ found that the highest compound annual growth rate (CAGR) involved rotating into a basket of consumer staples and health care stocks during the May to October period and then rotating back to a broad stock market index from the November to April period.
An investor who implemented any of these strategies over the course of the year, and is using only this indicator to make decisions for the equity portion of his or her portfolio that they actively manage, would be looking to rotate fully back into stocks soon.
Jeff Hirsch, editor in chief of the Stock Trader’s Almanac, author of The Little Book of Stock Market Cycles, and chief market strategist of the Magnet AE Fund, is a proponent of adding additional tools to improve such seasonal strategies. “For example, using the MACD indicator to better time entries and exits into and out of the best six months switching approach has a demonstrated history of improving returns,” Hirsch says.
Hirsch’s best six months system has involved investing in bonds on May 1, and then looking to switch to stocks entirely as early as October 1 using MACD. “In up-trending markets, MACD signals get you in stocks earlier, but if the market is trending down, the entries are delayed until the market turns up,” Hirsch states.
Be careful of investing based on seasonal patterns.
Market timing can be risky, past performance is no guarantee of future results, and active investors should not mechanically follow seasonal patterns and simply rotate entirely into stocks as the Halloween Indicator suggests.
You should evaluate each investing opportunity on its own merit and with an eye toward how it may perform in the future, rather than solely focusing on how it has performed in the past. Additionally, these types of seasonal strategies may be suitable only for active investors with shorter investment horizons, and even active investors need to consider their trading strategies within the context of a diversified portfolio that reflects their time horizon, risk tolerance, financial situation, and tax circumstance.
As always, there are other factors to take into account. Among them: global economic trends, the business cycle, company-specific trends, market-moving news, and geopolitical uncertainty. After conducting a thorough analysis of how these factors might affect your outlook, you might then consider the significance of seasonal trends like the Halloween Indicator.
Past performance is no guarantee of future results.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917