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OPINION

The power of seasons

The power of seasons
October 27, 2015
The power of seasons

You might think this was just good luck. After all, like most other people, I didn't foresee the depth or impact of China's slowdown.

But we don't need foresight to make good investment decisions - which is just as well, because accurate foresight is in fact almost impossible. Often, a knowledge of the past and present is good enough.

And there's one thing I knew back in May - that equity returns are seasonal. Since 1966 real total returns on the All-Share index have averaged 8.9 per cent from Halloween to May Day, but minus 0.8 per cent from May Day to Halloween. What's more, big falls are much more likely between May Day and Halloween than during the winter.

The likeliest reason for this is that our appetite for risk is seasonal. It is often too high in the spring which causes shares then to be overpriced, and too low in the autumn, which causes them to be underpriced.

The sectoral pattern of returns is consistent with the seasonality of risk appetite. Relatively defensive stocks such as tobacco and utilities have almost no seasonal pattern, whereas riskier ones - and especially sectors taking cyclical risk such as construction and miners - have a huge winter premium.

 

Sectors' seasonal returns
WinterSummerDifference
Construction/materials13.2-6.119.3
Electrical & electronics14.9-4.119.0
General industrials10.6-4.715.3
Mining10.5-0.911.4
All-share index6.3-0.97.1
Pharmaceuticals5.23.02.2
Tobacco6.96.50.4
Utilities4.34.5-0.2
Based on price changes since 1987. Winter is Halloween to May Day, summer is May Day to Halloween

It's not just in the UK that there is such a pattern. Ben Jacobsen at the University of Edinburgh and Cherry Zhang at Nottingham University Business School have found that almost all national stock markets throughout history have done better in winter than in summer.

 

Average All-Share returns since 1966

 

Common sense tell us that our appetite for risk is seasonal. This is expressed in our most ancient festivals. May Day is a celebration of hope while Halloween (or Samhain) marks fear and anxiety.

What's more, we know that many of our tastes are seasonal. We don't eat casseroles in July or strawberries in winter, and we listen to different music in winter than summer: does anyone play Leonard Cohen on a summer's day? Why, then, shouldn't our taste for risk also vary? As the Byrds (a summer band) quoted the book of Ecclesiastes: "To every thing there is a season."

A belief in the seasonality of equity returns is, therefore, soundly based in both history and theory. It's sufficiently robust to be the basis of an asset allocation strategy. Of course, it's not foolproof. Nothing is. But it has a far stronger basis in fact and theory than pretty much any judgment-based futurology.

This raises a question. Given all this, why is my decision to sell in May and buy on Halloween regarded as eccentric whilst futurological judgments are regarded as serious, despite their worse track records?

I suspect it's because my strategy challenges what Paul Krugman contemptuously called "very serious people". These are men - generally men and always besuited ones - who believe that management of money, companies or society requires arcane skills and knowledge which must be lavishly rewarded. In saying that you only need to look at the calendar to invest well, I'm rejecting this worldview.

I'm also saying that underneath the appearance of serious sobriety, these men are in fact as moody and skittish as teenagers - because it's their moods that drive the seasonality of equity returns.

In this light, it's not surprising that seasonal investing should meet with so much scepticism. As Upton Sinclair said, "it is difficult to get a man to understand something, when his salary depends on his not understanding it."