The Halloween Effect
One of the most underappreciated traits of successful investors is the ability to set realistic expectations. Whether it is the frequency of market corrections or historic market performance,having realistic expectations allows investors to avoid the two most dangerous emotions of in-vesting: greed and fear. Today, we will discuss the seasonality of the stock market, and how it tends to affect market returns.
Market seasonality, also known as the “Halloween Effect”, refers to the unique market phenomenon that involves the stock market having a historically “strong” six months and a historically “weak” six months. The strong season refers to the period of November through April, whereas the weak season refers to the period of May through October. Since 1950, the market’s strong season has averaged a return of 6.91%, whereas the weak season has averaged a modest return of 1.66%.
Surprisingly, there has yet to be a conclusive reason for this consistent occurrence in the market. While there are multiple theories behind this phenomenon, one of the most prominent ideas simply has to do with investor psychology. As the year begins to wind down and we head into the holiday season, investors tend to renew their optimism towards their investments and the new year in general. In the same way that an overly ambitious New Year’s resolution fades after a few months, the reality of the new year tends to set in for investors by the time summer comes around. This reality check coupled with summer vacationing has caused some analysts to suggest that this diminished investor involvement and optimism may be the cause for the lull during the weak season.
Now, you may be asking yourself, “Does this mean I should only invest from November to April, and then sell my investments in May?”
Well, not exactly. If you were to buy the S&P 500 in May 1950 and only own it during the weak seasons, you would have a gain of 149% as of today. Conversely, if you only owned the S&P 500 during the strong seasons over the same time frame, you would have seen a return of 9,283%, a significant difference. However, if you were to simply buy and hold the S&P 500 from May 1950 to the present, you would have seen a return of 23,251%.
In short, while the strong season significantly outperforms the weak season, the weak season also produces a positive return on average. With this in mind, you are able to have realistic expectations for your investments regarding seasonal market lulls and seasonal market strength.
