October 2018

Weekly Commentary October 26, 2018

Is the ‘Halloween Indicator’ a Trick or a Treat?
By Tim Courtney, Chief Investment Officer

In the past, we’ve talked about market indicators with foreboding names like the Hindenburg Omen,¹ and Death Cross.² We’ve also discussed the memorable motto, “Sell in May and Go Away,” whose proponents encourage investors to abandon the equity market from May to November to avoid seasonal volatility.³

With October coming to an end, we thought it would be a good time to address the aptly named “Halloween Indicator.”⁴ Basically a corollary to “Sell in May and Go Away,” it advocates getting back into the market now because the six months from November to April have produced higher returns historically.

Looking at the returns by month you do find that the months from November through April have indeed seen higher returns than the other six months.⁵ However, it is not at all clear that investing only in these months and avoiding the others makes sense. Consider these factors:

1. Returns in the “bad” part of the year are still historically positive. Our research indicates that if the market typically gains about 10 percent per year, then an average of 7 or 8 percent of that comes between November and April, while 2 or 3 percent is generated between May and October. While the winter months tend to be stronger, the summer months still offer positive returns. Sitting out of the market during the “bad” times would mean leaving returns on the table and, more importantly, missing out on the compounding effect of those returns.

2. Many market indicators aren’t particularly accurate. While market indicators prove to be correct some of the time, this is not always the case. The past five years represent a good example because many of these indicators have activated, warning investors to stay on the sidelines. However, if they did, they would have missed out on double-digit returns.⁵

3. Repeatedly trading in and out of the market can trigger significant taxes and fees. All other things being equal, we have a bias toward making fewer trades because of what we call “frictions” in the market. Essentially, these are the costs that erode your gains over time through trading fees and taxes. Even worse, if you trade multiple times per year, you become subject to short-term capital gains that are taxed just like wage/interest income.

In lieu of market indicators, at Exencial, we prefer to focus on pricing as the best gauge of future performance. Assets that are priced very high tend to have lower expected returns moving forward, while lower-priced assets often have higher expected returns over time. Think back to 2008, for example, when U.S. markets were priced very inexpensively and ultimately performed very well over the next 10 years. ⁵

How’s that for a Halloween treat?

Sources:

1. Investopedia – Hindenburg Omen
2. Investopedia – Death Cross
3. Investopedia – Sell in May and go away
4. Investopedia – Halloween strategy
5. Yahoo! Finance – S&P 500

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