Housebuilder first-quarter effect
Here’s how it works: in the first week of the year all you have to do is buy a selection of the UK’s largest housebuilders and hold them for three months. At the end of March phone up your stockbroker or spread betting company and close your positions, but most importantly, tell them to send you a cheque with your profits. It may sound simple, but if you had followed this trading strategy for the past three decades, you would have made a profit in the first quarter of the year on no fewer than 25 occasions netting an impressive 10.9 per cent average quarterly gain.
Superior Investment Return
The housebuilders not only outperform the benchmark UK index on average more years than not - 25 up years since 1980 compared with 21 up years for the FTSE All-Share index - but the quarterly return on the sector is significantly higher at 10.9 per cent compared to the average first quarter return of 3.3 per cent on the market (see table). And it gets better.
| Housebuilding Index first-quarter performance since 1980 | |||
|---|---|---|---|
| Year | Housebuilding | FTSE All-Share | Pair trade |
| 1980 | 6.6 | 4.6 | 2.0 |
| 1981 | 53.5 | 6.0 | 47.5 |
| 1982 | 18.0 | 4.3 | 13.7 |
| 1983 | 15.9 | 7.8 | 8.1 |
| 1984 | 4.9 | 11.4 | -6.5 |
| 1985 | -10.7 | 3.9 | -14.6 |
| 1986 | 30.1 | 18.7 | 11.4 |
| 1987 | 25.6 | 20.2 | 5.4 |
| 1988 | 10.9 | 3.0 | 7.9 |
| 1989 | 16.8 | 16.1 | 0.7 |
| 1990 | -7.0 | -7.4 | 0.4 |
| 1991 | 18.6 | 15.6 | 3.0 |
| 1992 | 7.5 | -1.4 | 8.9 |
| 1993 | 13.3 | 3.2 | 10.1 |
| 1994 | -4.0 | -7.1 | 3.1 |
| 1995 | 2.7 | 1.1 | 1.6 |
| 1996 | 5.1 | 2.2 | 2.9 |
| 1997 | 5.9 | 4.3 | 1.6 |
| 1998 | 21.5 | 15.4 | 6.1 |
| 1999 | 34.5 | 8.3 | 26.2 |
| 2000 | -16.2 | -4.1 | -12.1 |
| 2001 | 14.8 | -9.1 | 23.9 |
| 2002 | 12.0 | 1.3 | 10.7 |
| 2003 | 0.4 | -8.3 | 8.7 |
| 2004 | 19.0 | -0.5 | 19.5 |
| 2005 | 8.1 | 1.7 | 6.4 |
| 2006 | 8.3 | 7.1 | 1.2 |
| 2007 | 0.1 | 1.9 | -1.8 |
| 2008 | -6.5 | -10.9 | 4.4 |
| 2009 | 16.4 | -10.2 | 26.6 |
| Quarterly return | 10.9 | 3.3 | 7.6 |
| Up years | 25 | 21 | 26 |
| Down years | 5 | 9 | 4 |
Source: Trading Secrets: 20 Hard and Fast Rules to help you beat the stock market | |||
That’s because we can also pair trade the housebuilding sector against the UK market by buying shares in the seven FTSE 250 listed housebuilders - Barratt Developments, Bellway, Berkeley, Bovis, Redrow, Persimmon and Taylor Wimpey - and simultaneously short selling the market over the first quarter.
Since 1980, if you had bought a selection of shares in the house builders at the start of January and simultaneously sold short through a down spread bet the same value of the FTSE 100 (a proxy for the FTSE All-Share), this trade would have produced a positive return during the first quarter in no fewer than 26 of the past 30 years. The average return from this long-short trading strategy has been an eye-watering 7.6 per cent. And remember this strategy not only improves the chances of generating a positive return during the first quarter, but it also reduces investment risk.
Reducing investment risk
Granted, the 7.6 per cent net quarterly return is less than the 10.9 per cent return that would have been made by simply buying a selection of the UK’s housebuilders at the start of January. However, a quick glance at the results in 2008 and 2009 illustrates why this long-short trading strategy has its merits.
To recap, the UK stock market fell off a cliff in the first three months of the last couple of years, ending the first quarter down over 10 per cent. But even in the face of a savage sell-off across global equity markets, a strategy of buying the housebuilders and short selling the market produced a positive net return of 4.4 per cent and 26.6 per cent, respectively, in the first quarter of 2008 and 2009.
Risk aversion
These recent experiences highlight the risk averse nature of this long-short trade. Namely, if markets are rising - as they traditionally do during the seasonally strong winter months - then given the even stronger seasonal bias of the house building sector, the odds are heavily skewed towards the sector outperforming the market as a whole. However, if markets are falling in the first quarter - as they have done during nine of the past 30 years - then the housebuilding sector is far less likely to fall with the market. In fact there are five years - 1992, 2001, 2003, 2004 and 2009 - when the UK stock market fell in the first three quarter, but the housebuilding sector still produced a positive return. In these instances, investors would have made gains on both sides of the pair trade.
Reasons for the phenomenon
Housebuilding is a highly seasonal business with news flow and sales firmly skewed towards the all-important spring selling season. So at this time of year there is increased investor interest in housebuilders as investors focus on price trends and the strength of the underlying housing market. And as companies have a firm bias towards reporting financial results in the first quarter - since the majority have calendar or January year-ends - this also focuses investor attention on the merits of the sector.
There is also another reason why the sector outperforms the general market in the first quarter: this time of the year is when investing in ‘cyclical’ or ‘value’ stocks - that are very sensitive to changes in macroeconomic conditions - does well. Moreover, with the UK economy forecast to stage a recovery this year, and interest rates set to remain low in the foreseeable future, a modest investment in housebuilding shares is more likely than not to produce solid profits in the next few months.
* A full version of this article is published in Simon Thompson’s first book, Trading Secrets: 20 Hard & Fast Rules to Help You Beat the Stock Market.
