Now is the time to put new money into the market to capitalize on historical trends.
If you've been avoiding opening your latest 401(k) statement, it's time to pay attention. History says the U.S. stock market is set to break out of the starting gate for its best six months of the year.
Just like summer changes to autumn and then to winter, the stock market has its own seasons, too. From November through April each year, the U.S. stock market has consistently produced outsized returns over the period from May to October.
You may have heard the market adage: "sell in May and go away," but the flip side of that is "buy in October," says Jeffrey A. Hirsch, editor at the Stock Trader's Almanac in Nyack, New York. The publication is credited with first recognizing the seasonal phenomenon in 1987.
Since 1950, the Standard & Poor's 500 index has gained 7.1 percent, on average, from November through April versus 1.4 percent from May through October, Hirsch says. "Our historical market research revealed that most of the market's gains have been made from November to April, while stocks tend to go sideways and are more prone to downdrafts – as we have experienced this year – during the worst six months, May to October," Hirsch says.
What's drives stocks higher November through April? First, there is so-called mutual fund "window dressing," in which portfolio managers essentially clean house before third-quarter statements are sent to shareholders.
"Nobody wants to be holding onto a stock that is not doing well. If a company by the third quarter does not appear it will be able to turn around, fund managers move them out," says Sam Stovall, managing director at New York-based S&P Capital IQ.
The aggressive selling of stock losers generally "sets up the market for a yearly low in the October time period," Stovall says. Historically, he has found that "October has a greater percentage of correction and bear-market bottoms than any other month."
New money also tends to flow into the stock market at the beginning of each year as pension funds add to their holdings at that time, Stovall says. Also, investors scramble to fund their individual retirement accounts before the April 15 tax deadline, injecting capital into the equity market.
And some workers have a little extra money to invest at the end of the year. "Year-end bonuses tend to go right into the stock market, which increases cash inflows, stock buying and drives the market higher in the fourth quarter and first quarter," Hirsch says.
While Wall Street is expecting earnings per share to decline 5.1 percent in the third quarter this year, improvement is around the corner. Analysts are expecting quarterly year-over-year advances of 0.2 percent, 5.5 percent, 7.2 percent, 14.5 percent and 13.9 percent through the fourth quarter of 2016, according to S&P Capital IQ.
"I do expect fourth-quarter gains this year and a year-end rally. We are currently adding long positions to our portfolio," Hirsch says.
How do investors capitalize on the seasonal trend? "Investors should start looking to get back into stocks or be more aggressive in October, especially after a sell-off like we had this year. October, though feared from all the crashes and massacres, is the best month to buy stocks," Hirsch says.
The Stock Trader's Almanac has devised a "Best Six Months' Switching Strategy" that can be employed with exchange-traded funds. "Around September or October, the investor can buy the major market index ETFs: SPDR Dow Jones industrial average ETF (ticker: DIA), SPDR S&P 500 (SPY), PowerShares QQQ (QQQ) and iShares Russell 2000 (IWM). And then sell them around the April to May time frame, especially after a nice run-up," Hirsch says.
During the November through April period, Stovall has found that cyclical sectors, including consumer discretionary, industrials, technology and materials, tend to do well. Sector-specific ETFs include the Consumer Discretionary Select SPDR Fund (XLY), the Industrial Select Sector SPDR Fund (XLI), the Technology Select Sector SPDR Fund (XLK) and the Materials Select Sector SPDR Fund (XLB).
Aggressive investors could consider the S&P High Beta ETF (SPHB), which includes the 100 stocks that have the highest trailing 12-month standard deviation or more simply "the greatest wiggle over the last year," Stovall says. For investors who may be more comfortable riding a potential roller coaster, the S&P High Beta index has outperformed the S&P 500 since November 1990, with an average gain of 12.3 percent from November through April versus an average gain of 8.1 percent in the S&P 500.
When it comes to investing in the stock market, there are no guarantees, but putting seasonal trends on your side can help boost your odds.
"I think it's extremely important to pay attention to seasonal patterns and market cycles," Hirsch says. "It can give you an edge in making portfolio decisions. But it is not the only factor I consider, by far. I believe you increase your probability for maximum returns using fundamental and technical analysis in conjunction with seasonal and cyclical patterns and economic readings."
By Kira Brecht
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.
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