Investors have been driving the stock market higher thanks, in large part, to the U.S. Federal Reserve Board’s dovish stance on interest rates. Although it’s possible that the stock market could move higher in the next couple of months, historical seasonal trends dictate that caution should be used.
Investors tend to decrease their risk in the stock market during the summer months as they focus on other activities, including their vacations. In turn, trade volume typically decreases and the stock market tends to become more volatile. This is particularly true in August and September. Summer weakness often spills over into early autumn as investors return from their vacations and “get serious” about their holdings and clean up their portfolios. The result is that August and September are the two weakest contiguous months of the year in terms of performance, on average, over the long-term and are a “danger zone” for equities investors.
Since 1950, the S&P 500 index has produced an average loss of 0.5 per cent during the August to September period. August has been “flat,” on average, and September has produced an average loss of 0.5 per cent. (June has been the next-worst performing month of the year and, like August, also has been “flat” on average.) Yet, the S&P 500 index has generated gains 58 per cent of the time during the August to September period in the past 68 years.
Combining the fact that this period has produced an average loss but has been positive most of the time, over the long-term, translates into the following: when losses occur in the August to September period, they tend to be larger than the gains experienced during these same months in other years.
On a risk-reward basis, this is not a good time to be fully invested in the stock market as it’s not possible to determine if the August to September period is going to be positive in any given year. The danger is that if the stock market does suffer losses, then those losses could be large.
From 1950 to 2018, the S&P 500 index produced losses of 10 per cent or greater seven times during the August to September period, with the biggest loss of 19.8 per cent occurring in 1974. This compares to gains of 10 per cent or greater occurring only twice during these two months. The largest gain of 12.5 per cent occurred in 1982, at the start of a major bull market. Thus, the large losses that have occurred during this period are much larger and take place more often than the large gains.
In strong bull markets, it’s expected that the stock market’s performance would be stronger than the long-term average in all months. During the past 10 years, the S&P 500 index has been in a strong bull market, producing an average annual gain of 11.3 per cent. In the August to September period, the S&P 500 index has only produced an average gain of 1 per cent and has been positive 60 per cent of the time. The average monthly gain in this period has been substantially lower than the average monthly gain during the rest of the year.
Some investors may point to the positive performance experienced during these months as a reason why they should always be fully invested in the stock market during the summer. However, the risk-reward benefit of being invested in August and September is substantially lower compared with the rest of the year. In addition, the recent bull market trend has been an anomaly compared with the long-term trend.
The major North American stock markets are at or close to all-time highs. However, there are many cross currents currently pushing them around. The global economy is showing signs of weakness and central banks are taking action to help support the economy and the stock market, indirectly. Are their actions too little, too late – or will they have desired impact in a timely fashion? Is the bull market over? Will the stock market be positive or negative in the August to September period this year? No one knows the answer to any of these questions. What we do know is that historically, these two months have been a dangerous time to be fully invested in equities and have earned the “danger zone” moniker.
Nevertheless, many pundits often point out that a stock market correction is a particularly good time to buy stocks – and a correction that happens during the “danger zone” is no exception. In fact, corrections that have occurred in the August to September period have often led to good entry points in the market. Seasonally, the best six-month period of the year for the stock market starts on Oct. 28 and lasts until early May 5 of the following year. A correction just before the start of this favourable period can make for a timely opportunity to increase exposure to equities. Indirectly, the “danger zone” could truly be an “opportunity zone.”
Brooke Thackray is research analyst at Horizons ETFs (Canada) Inc. He focuses on technical analysis and seasonal investing.