Alpha Power Investing Newsletter

March 1, 2019

Seasonality in the U.S. Domestic Stock Market

In our February 2019 newsletter we highlighted the fact that seasonality in the stock market is a worldwide phenomenon. This month we return a little closer to home to highlight just how pervasive - and potentially useful - seasonality is as a factor in the U.S. domestic stock market.

The Goal: Consistent Returns
If there is one thing that helps investors stick with any strategy long enough to achieve their investment goals it is "consistency". Let's define what we mean by consistency a little more specifically. Generally speaking, the volatility of the returns one achieves, and the amount of time spent "underwater" are key factors in determining an investor's long-term success. Too much volatility - i.e., inconsistent returns, and/or too much time spent trying to climb back from a decline in equity, can sap an investor's will to remain disciplined.

If an investor can achieve a certain rate of return without great fluctuations in the equity in their account, this is often preferable to earning a slightly higher rate of return that requires an investor to ride large up and down swings in equity. Likewise, when an investor is in a "drawdown", i.e., when their account equity is below its previous peak, that's when doubt creeps in and an investor can feel a need to "act" when in reality they should be sitting tight and letting their strategy work over time.

The U.S. Domestic Power Zone
At Alpha, we define the "Power Zone" as the months of November through May. The phrase most commonly associated with this period is "Sell in May and Go Away". We commonly refer to the remaining months of the year - June through October - as the "Dead Zone." So what we want to do is analyze the performance of a variety of U.S. indexes during these two periods.

Indexes Range Far and Wide
Over the years the U.S. stock market has been subdivided into a variety of different "classes", and many indexes have been created to track securities that fit into each class. A representative list might include indexes in the following categories:

*Broad-Based *Large-Cap
*Mid-Cap *Small-Cap
*Growth *Value
*Momentum *Low Volatility
*Equal Weight *Dividend Focused

This list is by no means exhaustive. For example, there can be overlap between those listed above - i.e., Large-Cap Equal Weight, Small-Cap Growth, Mid-Cap Value and so on. Many mutual funds and ETFs have been created to allow investors to target specific market segments such as those on the list and others. But for now, our purpose is to find a consistent approach to investing in the market.

One Way to Measure Consistency: Five-Year Rolling Rates of Return
A single five-year return simply measures the change in value of something over the most recent five years. Five-year rolling returns simply involve looking back five years on a specific date each year over a period of time and measuring how often a gain is achieved as well as the magnitude of the average five-year gain (or loss).

When an investor embarks on an investing campaign with a given strategy, it is reasonable to assume they might have a five-year time horizon. One thing that can help them maintain the discipline to follow through is if they have confidence that they will come out ahead five years down the road. While past performance never guarantees future results, analyzing five-year rolling returns can give an investor a sense of the likelihood that they will come out ahead five years hence. In other words, a high percentage of positive returns over previous five-year periods may suggest a higher degree of consistency than a lower percentage of positive returns.

Holding ONLY during the "Power Zone" for Five-Year Rolling Periods

  • For our test, we will look at a variety of U.S. Indexes.
  • We will track the cumulative gain or loss achieved by holding each index ONLY during the months of November through May of every year over five-year rolling periods.
  • We will then measure the percentage of times each index shows a cumulative five-year gain (as well as the magnitude of the average five-year gain or loss).

The indexes in Figure 1 are listed in order of when monthly total return data is available from the PEP database from Callan Associates.

Column 1: Name of the Index
Column 2: First year of available data
Column 3: # of five-year rolling periods tested
Column 4: # of five-year rolling periods that showed a gain
Column 5: % of five-year rolling periods that showed a gain
Column 6: % of five-year rolling periods that did not show a gain
Column 7: Average five-year % gain or loss

The key thing to note in Figure 1 is the extraordinarily consistent performance of the stock market - across virtually every segment of the market - during the Power Zone. The vast majority of indexes showed a gain during 100% of all previous five-year periods considered and all but one index showed a gain during at least 95% of all previous five-year periods considered.

As always, past performance does not guarantee future results. Still, most investors would likely be hard pressed to find a more consistently positive performance factor than the "Power Zone". Simply buying and holding any of a wide variety of indexes during November through May has consistently generated gains over a period of several decades. In addition, most investors would likely be hard pressed to find a simpler, more efficient approach to achieving long-term growth of equity.

We believe that consistency and simplicity are solid cornerstones for any investment strategy.

Jay Kaeppel
Vice President and Director of Research
Alpha Investment Management, Inc.

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in the chart above do not represent actual trading and are not representative of any Alpha Investment Management strategy. The data does not include management fees or the cost of funds, trading, or other expenses. The illustration is designed to quantify the effect of certain time periods (as specified) on various indexes. Indexes are not investment vehicles and persons cannot invest directly in an index.  

The data used to construct the illustration was obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  

Alpha Investment Management, Inc. is a registered investment advisor located in the State of Ohio. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

© 2019 Alpha Investment Management, Inc.

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