Seasonality 101: Back To The Basics of Seasonal Investing
Investment portfolios have been hit hard this summer. Individual investors are fearful of placing assets at risk due to higher than average volatility. Equity mutual funds have not fared well with average performance year to date down 2%. The days of easy money have come to an end leaving money managers looking for alternate analytical techniques to improve future returns. Seasonal analysis is an interesting supplement to traditional fundamental and technical analysis.
Prudent investors will consider all three analytical approaches in order to answer the questions that investors seek most: what and when. In the world of investments, fundamental analysis attempts to identify “what†to invest, while technical analysis attempts to explain “whenâ€. The bridge between the two is seasonal analysis. Seasonal analysis defines when to start and end an investment based on technical analysis and what to own during the period based on the fundamental analysis of annual recurring events.
Analysis of annual recurring events is key to the feasibility of seasonal investing. Are the annual recurring events happening this year or not? Take for example the period of seasonal strength in the overall market. Annual recurring events that move the tape in a positive fashion from October to April include year-end financial results and guidance, holiday spending, tax sensitive events and increased market liquidity following the quieter summer season. Events lined up nicely this past year. Gains by the S&P 500 Index, TSX Composite Index and Dow Jones Industrial Average during the fourth quarter of 2009 and the first quarter of 2010 averaged around 10%. All indices plummeted as soon as their period of seasonal strength concluded.
Investors can exploit the October to April period of market strength by investing in cyclical stocks that are influenced by economic activity. Preferred sectors include consumer discretionary, technology, industrials, materials and financials. The remainder of the year requires appropriate positioning in defensive sectors such as health care, utilities and consumer staples.
Seasonal influences are not restricted to equity prices. Volatility in equity markets seasonally appreciate from July into October primarily due to thinner trading activity. Gold historically has performed well during the July to October period thanks partially to additional purchases of bullion by fabricators who make jewelry for the Indian wedding season. Bonds receive a boost starting in May when confidence in equity markets wane and when safe haven plays are sought.
Investors can determine seasonal profiles by analyzing data from 10 to 20 year charts showing outperformance compared to an appropriate benchmark. After periods of outperformance are determined, investors can refine their entry end exit points by using momentum indicators, such as Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI) and Stochastics. These common technical analysis tools provide confirmation of a seasonal move. Technical signals can occur either before or after pre-determined average seasonal start and exit dates. Finally, once fundamental prospects based on annual recurring events are applied, the investment thesis “trifecta†is complete.
Seasonality analysis is nothing new, but it remains an area that is little understood. It is more than just dates and it should never be used alone when making investment decisions. It is a disciplined approach. Users of seasonality will be taken from a world of guessing their next move to a world of what and when to invest.
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