🍂 'Tis the season(ality)

Hey hey, happy Monday! 

‘Tis the season for pumpkin spice lattes, college football and fuzzy sweaters. Oh, and obnoxious seasonality stats.

Some market experts swear by seasonality analysis, or predicting the stock market’s next move based on the calendar. Today, I’m going to explain to you in just 5 minutes why nothing in life is ever that simple – especially when it comes to your money.

That’s right, folks. ‘Tis the season to take down the seasonality warriors.

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When it comes to investing strategies, there are two classic schools of thought on Wall Street.

There are fundamental analysts (like muah) who think long-term trends in the economy – consumer health, corporate profits and technological innovation – drive stock prices higher. We tend to tell you to chill out when the S&P 500 – an index of America’s biggest publicly traded companies – has a bad day or two, because look at the underlying data! Everything is fine! Mood swings are normal – I woke up cranky today, too!

Then, there are the technical analysts. They love to draw lines, curves and cup and handle patterns on charts to derive signals on where the stock market could go next. They focus more on short-term events, mood swings, and the movement and relative highs of different stock groups.

If fundamental analysts were the students diligently double-checking the teacher’s work, technical analysts were the ones scribbling on the desks who could always muster up a cohesive answer if they were unlucky enough to be called on.

I kid, I kid. I know (and work with!) a lot of brilliant technical analysts, and there is something to the idea that an object in motion stays in motion. I don’t argue with Isaac Newton and his laws.

But today, I need to call out one of their worst practices: seasonality analysis.

The pursuit of predicting stock market returns based on the calendar.

Tell me if you’ve heard this one before.

September is historically the S&P 500’s worst month of the year, falling an average of 0.7% in all years since 1950. Yet, this September was actually the third-strongest month of the year, with the S&P 500 climbing 3.5%.

Here’s another one.

October is historically the bumpiest month of the year, with the S&P 500 moving an average of 0.8% daily in every October since 1950. But if you’ve paid attention to the first three days of this year, you’ll notice that the stock market has barely budged during a freaking government shutdown. This isn’t what I paid for, Mr. Newton!

I get questions about seasonality all the time from clients. The concept is alluringly simple – if you know the 12 months of the year, then you can build a successful portfolio. The mantras are catchy. Sell in May and go away! Here comes the Santa Claus rally!

In an industry where things are rarely simple and catchy, calendar-based investing stands out.

But seasonality alone is far from a valid investing strategy, especially if you’re eyeing goals years down the road.

It forces you to make a dangerous assumption: that the stock market trends toward averages.

This couldn’t be further from the truth. Yes, I often cite that the S&P 500 has returned about 8% annually on average since 1950 (excluding dividends). Averages can make good rules of thumb to use when understanding the power of your diversified stock portfolio over time.

8% certainly shouldn’t be an expectation, though. Here’s the distribution of the S&P 500’s 12-month returns since 1950 – a sample size of more than 18,000.

About a fifth of these returns were gains of 0.01 to 9.99%, or the bucket into which 8% would’ve fallen. And just 2.7% of these returns were gains between 8 and 9%.

Average is not really a thing in the stock market, even though averages can tell us a lot about what to expect over long timeframes.

The problem here is that seasonality requires you to believe in this chart of the S&P 500’s average path each year:

You could tell a compelling story from this one chart. Stocks tend to march higher in the first quarter, even though they’re rattled by a little bit of volatility in February and March. The gains taper off from May to October, then resume when the market rockets higher into the fourth quarter. This is the logic that  “sell in May and go away” is based on, by the way.

However, remove the S&P 500’s best and worst years over this period, and you’ll see a strikingly different story emerge.

Here’s the average year chart with 1954 separated out, a year when the S&P 500 climbed 45% to its first high since the Great Depression.

In 1954, there was no good time to sell. Technically, the third and fourth quarters were the strongest of the year, with the S&P 500 gaining more than 20% in the back half of the year. In that year, selling in May and going away set you back significantly.

Here’s the average year chart with 2008 separated out, a year when the S&P 500 fell 39% during the global financial crisis, with the bulk of the crash happening in the second half of the year.

Seasonality couldn’t have saved you here, either. The fourth quarter, which has the best average returns of any quarter since 1950, was 2008’s worst stretch with a 22.6% drop.

I’m reaching for extremes here, so let’s open the door up a little more. Below are the S&P 500’s five best and worst years since 1950, lined up against the average year chart.

No seasonality patterns here, boss. 

These years define your portfolio more than you think, too. Take the S&P 500’s strongest 12-month gain in recent history: the astonishing 74.8% rally from March 2020 to 2021. One of the darkest periods in American history, full of death, sickness, despair and conflict.

Honestly, you probably couldn’t keep up with the seasons then – or maybe you were hyper-focused on them because we were all stuck in our houses. Things were weird. Regardless, selling out of a hypothetical S&P 500 stock fund in May and buying back in towards the end of October meant you missed out on a fifth of that entire rally. Yes, the market’s momentum slowed in those six months, but it didn’t stop.

Seasonality can also lure you into bad trading habits. Frequent selling often means higher tax bills and brokerage charges. Calendar-based buying and selling may be objective, but it also puts you in a position to make more decisions, which can ultimately lead you to emotion-based choices. It can’t be good for your sanity, either.

I’ll cut my technician friends a little bit of slack here. Seasonality studies aren’t made for people like us. They’re ideal for investors trying to find good entry and exit positions for investments they were going to make, regardless of what month it is. They’re interesting examples of how history can repeat itself once in a while, and they make for great headlines. If you’re a markets reporter, you eat these seasonal patterns up.

I’m all for more knowledge, too. Investing while knowing that the stock market may be more prone to a selloff because of seasonal (and/or fundamental) patterns could help you prepare for what’s next. If we do hit a soft patch, maybe you prep your cash hoard so you throw an extra slug into the market at a moment’s notice.

As we head into the notoriously Santa-charmed fourth quarter that can sometimes start with a scary season, maybe it’s time to examine why you think the way you do about the stock market.

Maybe you’re a technician. Perhaps you’re more meat-and-potatoes fundamentalist than that.

Either way, the best approach is what works for you and your goals.

Don’t leave the fate of your nest egg up to a flimsy calendar.

Thanks for reading!

Callie

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