One of the most common questions I’m asked is, “Is there a time of year that’s best to invest my money?” It’s a valid and serious question and the answer is actually, “yes and no”.
Mah Ching Cheng, research manager at Fundsupermart.com, has written an excellent white paper on the subject. He says, “There have been numerous studies carried out to show that there are periods when markets exhibit some peculiar characteristics. During these periods, markets behave in a way, which seems to imply that there is a good time to enter or exit investments. The term ‘calendar effect’ refers to a particular period when stock markets react in a peculiar fashion.” So, let’s look at some common thoughts on some specific months.
Also called the “year end” effect, the January effect refers to the conspicuous rise of equity markets during the period starting the last day of December and ending the fifth trading day of January.
- In a study, Robert Haugen picked January as the month when average returns are higher than average monthly returns for the whole year.
- Corporations and individuals close their tax books at the end of December and are more willing to sell their investments to create a tax-loss situation.
- The December sell-out may temporarily depress stock prices and bargain hunters tend to start buying at the beginning of the following year, causing some form of market frenzy during the early party of January – hence “January effect.”
Is there a “worst month to invest?” The October effect postulates that equities tend to decline in October because investors get jittery at the historical precedent of market crashes occurring in this month. October 1929, which preceded the Great Depression, and the great crash of 1987 (Black Monday) are examples.
Turn of the month
U.S. large-cap stocks consistently posted higher returns at the turn of the month in a study over a period from 1928 to 1993 (Chris R. Hensel and William T. Ziemba). This is attributed to cash flow at the end of each month when salaries and interest payments were made to investors, who were then assumed to use those monies to purchase stocks.
Testing the assumptions
Mah Ching Cheng went back and looked at these effects and did back testing. Cheng looked at 18 years from 1989 to 2006 and examined stock indexes from the United States and abroad. He found August had the highest probability of a negative return.
So, it’s August, not October that shows the most frequent number of negative returns in the past 18 years. In fact, the data reflected only a 38.9 percent chance of negative returns in October. Given this, it’s clear that October does not deserve its bad reputation.
Using the same parameters, the probability of positive returns in November and December is higher than in January. So, empirically, December beats January as a time to invest – hence, the Santa Claus rally effect.
While Mah Cheng’s study drew some interesting conclusions based on empirical evidence, one thing still holds true – the only certainty that equity markets face is uncertainty.
By Mark A. Chandik, President/Chief Investment Officer, FDP Wealth Management
Mark Chandik was awarded the 2018 Five Star Professional Award.
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