Use Seasonal Patterns to Trade Stocks

US equities got off to a rocky start to 2021, with each of the major indices falling around two percent before closing just off their lows for the session. As always, there are a range of factors currently at play which are impacting stock prices. For example, the continued rampant spread of the Coronavirus in several key economic regions, the potential for the Georgia Senate run-offs to change the balance of power in the US Senate, and question marks over whether we will get a smooth transition from the current Trump administration to a Biden one. We could go on…

But, underlying the day-to-day ebb and flow of headline grabbing market matters, we often find that there are “seasonal patterns” at play. A seasonal pattern is a move in a market, it could be in a commodity like coffee, or in a stock market index like the S&P500, which tends to occur around the same time each year. We say “tends to occur” because seasonal patterns are calculated by looking at the average price movements of a particular market at certain times of the year. And whilst there are generally repeating actions by market participants which contribute to seasonal patterns, for example, harvest time for an agricultural commodity, there are no guarantees that seasonal patterns are going to play out in any future year.

In the stock market, and we will focus on the largest and the most influential benchmark index in the world, the S&P500, there are several clear seasonal patterns investors should be aware of. Perhaps the best-known pattern is the “Santa Claus” rally which gets its name from the tendency for the S&P500 to rally in the period leading up to, and shortly after Christmas. In fact, since the year 2000, nearly half of the index’s average annual return came in the three months between October and December. 

Impressive. But did you know that there is an even better three-month period of the year for the S&P500 over the last 20 years? The months of March, April, and May have typically delivered the best three-month return with an average 3.5% gain over the period. That’s roughly half of the S&P500’s average annual return since 2000.

You’ve probably heard the well-worn investing phrase “Sell in May and go away”. Now you know part of the reason why. The rest of the puzzle lies in the fact that June is on average a bearish month for stocks. Since 2000, it tends to see just over 0.5% wiped off stock prices. The most bearish month of the year by far though is September, with an average 1.1% decline.

Which brings us to the current price action in the S&P500. Much like June tends to be a “hangover” month following the strength in March-May, January (-0.3%) and February (-0.7%) tend to undermine the Christmas cheer from the October-December rally. Setting aside September’s typical big drop, January and February are on average the most bearish consecutive months of the year. So, perhaps we need a second stock market adage, “Sell in January, and come back in March!”.


(Source: AusbizTV January 4, 2021. "ETFs to play the Asia Resurgence this year". Available from: https://www.ausbiz.com.au/media/etfs-to-play-the-asia-resurgence-this-year?videoId=6375)
 

Oct-Dec +2.9%
Jan-Feb -1.0%
Mar-May +3.5%
September -1.1%

(Since 2010 Dec high to Jan/Feb low)
2020 -3.6%
2018 -11.8%
2016 -13.0%
2015 -5.3%
2014 -6.1%
2010 -9.2%