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‘Santa rally’ is real, and so are other seasonal market trends

The “Santa Claus rally” is the strongest three-week period of the year for the U.S. equity market, with an average return of 2 per cent over the past 61 years. Not every year was profitable, of course, but well over two-thirds of them were.

Kathy Willens

Those who cannot remember the past are condemned to repeat it, Spanish-American philosopher George Santayana famously warned. Perhaps my colleague John Heinzl forgot that message of the importance of learning from history when he wrote that investors shouldn't waste their time looking at trends and patterns.

For sure, there are some absurd theories that get way too much attention, such as the "Super Bowl Indicator" that suggests a bear market will follow a win from the old American Football Conference. The indicator's track record of being right about 80 per cent of the time is surely just coincidence.

But there are many seasonal trends and historical patterns backed by intelligent and logical explanations that can significantly increase the odds of a successful investment call. This isn't about superstition or random anomalies, but regularly occurring events every year or during certain periods of time that can influence markets.

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This time of the year, for instance, we hear a lot about the "Santa Claus rally." It's not just the arrival of Jolly Old St. Nick stirring up festive feelings on trading floors; a number of reoccurring events take place in late December that are positive for markets. Investment dealers often issue bullish annual outlooks, higher consumer spending bolsters corporate bottom lines, year-end bonuses and bond interest payments provide investors with more cash to put into the stock market. Many fund managers are polishing up their portfolios ahead of year-end, too, and are hunting for bargains or increasing positions in winning investments.

The "Santa Claus rally" is the strongest three-week period of the year for the U.S. equity market, with an average return of 2 per cent over the past 61 years. Not every year was profitable, of course, but well over two-thirds of them were.

There will always be times when seasonal patterns don't hold true. If they did, well, there wouldn't be a market; nobody would be willing take a position against a trend with 100 per cent accuracy. A seasonal trend is only worth investing in if it's profitable more than 50 per cent of the time, and preferably over 70 per cent.

Some sectors within the stock market are especially subject to more profitable trades at certain times of the year, and there are very concrete reasons why. For instance, the oil sector tends to rise from late February to early May because refineries convert from heating oil to gasoline production for the summer driving season, increasing demand for crude. Base metals such as copper and nickel tend to move higher from November to May each year because consumption of industrial materials rises each spring when housing construction heats up and consumers buy new automobiles.

So just how successful is this antithesis of buy and hold investing? It's hard to quantify, but let's look at the returns of the Horizons Seasonal Rotation ETF. This exchange traded fund was launched in November of 2009 to actively invest in markets or sectors that typically rally in different parts of the year. Since launch, its total return has been 24.5 per cent, compared to the S&P/TSX composite index's gain of just 5.7 per cent. Not too shabby. The ETF doesn't have a long enough track record to put a lot of faith into its returns. But consider this as some evidence that a trend can be a good friend when deciding whether to buy or sell.

Now, it's important to be clear here: Nobody should solely base their investment decisions on past trends. Combine it with fundamental analysis, such as analyzing a company's financial health and the macroeconomic environment. Technical analysis has its part, too, in providing clues on how to time the market more accurately.

I thought Don Vialoux, one of Canada's top gurus of seasonal trading and an adviser for the Horizons ETF, put it best when discussing this investing approach in a recent live web discussion with me at our Inside the Market blog.

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"Seasonality analysis is useful when combined with other forms of analysis. Never, ever buy an equity based solely on seasonality. Similarly, never ever buy an equity based solely on technical analysis and never ever buy an equity based solely on fundamental analysis. The secret is to combine the three forms of analysis. Chances of success are greatly enhanced."

READERS: What do you think of seasonal trend investing? Have you invested more in the market because of the anticipated Santa Claus rally? Or do you agree with John Heinzl's "invest for the long haul" approach? Are there any historical trends that you believe are especially valuable when making portfolio selections?

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