Investopedia/Alan Farley: How To Think About Seasonality Trends

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How To Think About Seasonality Trends By Alan Farley | October 13, 2015 — 7:03 AM EDT
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When analyzing a company’s prospects as a short-term trade or long-term investment, it's important to note that seasonality trends impact performance expectations. These well-documented periods of strength and weakness affect all sectors, which is why it's crucial to examine the best times of year to open new positions, even if one is buying for the long haul. 

In additional to seasonal trends, quarterly earnings mark a regular calendar influence that can yield big losses when investors place ill-advised bets. While careful research may tell you if a company is likely to beat expectations, it can’t accurately predict the subsequent reaction, which can trigger price swings in excess of 10%, even in blue chips and Dow components.
Index Seasonality

Major indices grind through broad ranges each year. Statistics going back for decades show the strongest gains are usually posted in the first five months of the year and the fourth quarter, with the June through September period marked by corrections and shakeouts. This data tracks the classic market wisdom to “sell in May and go away”.

SP-500 Monthly Performance 1980-2014

MONTH
   

RETURN

January
   

0.95%

February
   

0.17%

March
   

1.05%

April
   

1.59%

May
   

0.92%

June
   

0.07%

July
   

0.56%

August
   

-0.06%

September
   

-0.77%

October
   

0.99%

November
   

1.45%

December
   

1.52%

Sources: Standard & Poor's 500 Index and Money Chimp

Seasonal trends start with the January effect, in which profit and loss calculations are wiped clean, encouraging risk-taking in companies that booked poor returns in the prior calendar year. The year ends with the Santa Rally, when institutions review their holdings, often buying the biggest winners to bolster their annual reports. In-between, summer markets can be frustrating, with the main market groups often grinding through their weakest price action of the year.
Sector Seasonality

In addition to seasonal trends that impact the broad averages, sectors transit through relatively strong and weak periods that show persistence over decades. Choosing to buy when these influences are favorable can significantly add to first-year returns. While poorly-timed entries can rob confidence while undermining the annual profit and loss statement.

Small caps get bought more aggressively in the first quarter due to the resumption of risk appetite triggered by the new calendar year. Positive seasonality ends on March 31 with relatively weak performance expected until the middle of the fourth quarter, when these stocks can get bought aggressively in anticipation of a year-end rally. 

The Oil and the energy sector shows well documented seasonal patterns. For example, for the last 25 years, the NYSE ARCA Oil & Gas Index (XOI) has posted relatively strong gains from the middle of December into the late spring or early summer. This trend originates from the run-up to the U.S. summer driving season, with a noticeable peak around Memorial Day. XOI has no ETF equivalent, but SPDR Select Sector Energy Fund (XLE) offers a closely aligned proxy.

Technology Seasonality 1994 - 2013

Technology Seasonality

Technology is traditionally strong in the fourth quarter, lasting into January of the following year. It enters a second seasonally strong period between April and July, with performance then decreasing until the October buying spurt. One useful strategy is to buy the sector’s biggest names during strong periods while focusing on special situations during weak periods.

Not surprisingly, bonds and precious metals show seasonal strength in opposition to major equity indices. This is a result of the risk-on-risk-off mindset that rotates capital based on relative greed and fear levels. Gold shows the greatest annual strength between July and October at the same time the SP-500 books its weakest performance of the year while bonds enter seasonal strength in May and relinquish it in October.
The Bottom Line

Investors benefit when company research incorporates seasonality trends that predict relative strength and weakness throughout the calendar year. Also, it pays to follow Standard & Poor's 500 Index and broad market trends to determine the likelihood of higher prices at the time you want to take exposure.
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