The 'January Effect' and Stock Market Seasonality

Several phrases pop up now and then in the financial news that suggest some times of the year are more favorable for investing than others. But is stock market seasonality, in which certain months have exhibited positive or negative trends, grounded in sound investment principles?

Below are three common calendar-based investment sayings that have been around for a while. Do they have merit? Let's set the record straight.

What Is the January Effect?

The January Effect refers to the perception that the stock market rises in January more than any other month. Academics decades ago called attention to the pattern, and over time there have been different explanations for it.

In recent years, tax-loss harvesting is the most frequent cause cited for the January Effect. After selling some of their stocks at year-end for tax purposes, investors reenter the market in January. (Tax-loss harvesting activity typically picks up between October and December although it's a year-round tax-mitigation strategy.)

Similarly, investors reengaging in the market and rebalancing portfolios after the holiday season may be another source for bullish January behavior.

With that said, the January Effect has diminished over the years and is not statistically significant—in other words, it's not a reliable investing strategy.

Sell in May and Go Away

The financial adage to sell in May encourages investors to avoid a period of market decline over the summer and fall. You would then reinvest in November after what at times has been a volatile period.

There used to be some data behind the idea. From 1950 to 2013, the Dow Jones Industrial Average showed lower average returns from May to October, compared to November through April.¹ However, since 2013, it hasn't held up.

More importantly, jumping in and out of the market based loosely on a trend can lower your returns substantially.

The catchphrase "sell in May" is related to another seasonal market trend, the "summer doldrums."

What Are the Summer Doldrums?

The tendency for market activity to slump from June through August dates back centuries when London bankers and merchants "went away" and spent summer months in the country.

There is some modern-day merit to these so-called doldrums: The S&P 500 Index often experiences some of its lowest trading volume³ of the year at the height of the summer vacation season, from the week leading up to the U.S. Fourth of July holiday through the Labor Day holiday the first week of September. (Another dip usually occurs during the end-of-year holiday season.)

Some professional traders view trading volume of a particular security as part of their technical analysis alongside other factors. However, fewer active buyers and sellers in the market around the major holidays is expected, and the lighter volume on its own is not meaningful.

Are Seasonal Stock Market Trends Your Friends?

As long-term investors, our investment teams do not trade in anticipation of calendar-based anomalies. We have found that there is no substitute for doing your homework on a security to determine its long-term prospects. Buy and sell decisions are not synced to a calendar but are based on in-depth fundamental analysis.

Each of the phrases discussed is based on a pattern observed at one time or other, but an observation is by definition past performance (which we all know doesn't guarantee future results).

Most importantly, trading driven by seasonal market trends is a form of market timing, and no one can predict the optimal time for getting in and out of the market.

You might say, the trend is your friend—until it ends.