Being Street Smart 10/21/7

BEING STREET SMART
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Sy Harding

THE MARKET REMAINS IN ITS UNFAVORABLE SEASON. October 19, 2007.

In the spring, and again in the fall, I remind you of the stock market’s long history of seasonality, of making most of its gains in the late fall and winter months, and suffering most corrections that come along in the opposite period, what I call its unfavorable season.

Some background: In 1998, I was becoming worried about the growing bubble in the stock market, and began looking for a strategy that would allow investors to continue to participate in the bull market, but provide a means of not giving the profits back in the inevitable next bear market. After going down many trails in the research it became clear the market’s historically consistent seasonality held the most promise, and I concentrated my firm’s research in that direction.

I called the resulting strategy the Seasonal Timing Strategy, and introduced it in my 1999 book Riding the Bear – How to Prosper in the Coming Bear Market.

It did work as well as the research indicated it should. Over the eight years since 1998, by investing in an index fund on the Dow for the favorable seasons, and collecting interest on cash in the unfavorable seasons, the strategy more than doubled the performance of the Dow, S&P 500, and Nasdaq. That is remarkable, since more than 80% of mutual funds and money-managers fail to even match the performance of the benchmark S&P 500 over the long-term.

Yet, the Seasonal Timing Strategy outperformed the market in only four of the eight individual years. The difference was that it significantly outperformed in years when the market had corrections, since seasonal investors did not give back the gains they made in the favorable seasons.

To remind you, the rules are simple, incorporating only a calendar and a fairly well-known technical charting tool, known as MACD. The latter is a short-term ‘momentum-reversal indicator’, available free on websites like BigCharts.com. The indicator triggers short-term momentum-reversal signals, or so-called ‘buy and ‘sell signals’ throughout the year. They are all ignored except in the fall when a seasonal investor is looking for a signal to re-enter the market, (and in the spring when a seasonal investor is looking to exit).

My 1998 research discovered that on average the best date to enter in the fall is October 16. However, it also revealed that the length of the favorable and unfavorable seasons vary significantly from year to year. So we incorporated the use of MACD, to be used in conjunction with the calendar, to better pinpoint the entries and exits.

The rule is that when October 16 arrives, if the MACD indicator is on a ‘buy signal’, that is showing that short-term market momentum is to the upside, the entry is to be made at that time. However, and this is the biggie, if the MACD indicator is on a ‘sell signal’, indicating that short-term market momentum is to the downside, the entry is delayed until MACD triggers its next ‘buy signal’. That has delayed the entry in some years to as late as late November.

In the spring, the best exit date on average is April 20. However the same MACD indicator is used to sometimes delay the exit. The rule is that if MACD in on a buy signal when April 20 arrives, the exit will be delayed until MACD triggers its next sell signal. In some years that has extended the ‘favorable season’ by as long as two months.

This year has been very interesting. The exit signal was triggered on May 15, which extended last year’s favorable season by about a month, and allowed for additional gains. During the unfavorable season this summer the S&P 500 experienced a 10% correction in July and August, while seasonal investors were safely on the sidelines adding to profits from interest on cash. It looked like the Seasonal Timing Strategy would surely re-enter in the fall with the market at a lower level than the May exit, and so would easily outperform the market for the year.

However, as you know, the market rallied back off the August low, reaching new highs, and the seasonal investor was behind by two or three percent even counting the interest being earned on cash.

Worse, MACD was recently still on a buy signal as October 16 approached, making it look like the seasonal investor might be entering near those high prices. That had me worried given the many negatives that have been piling up for the economy.

Fortunately, or so it seems at this point anyway, the market lost enough momentum that as of the close a week ago Friday, MACD triggered a ‘sell signal’. And since it remained on that sell signal on Tuesday, October 16, the seasonal entry will not take place until it triggers its next buy signal.

So the market remains in its unfavorable season. And given what has happened this week I couldn’t be more pleased.




Sy Harding is president of Asset Management Research Corp., publishes the Street Smart Report newsletter, and a free daily Internet blog at www.SyHardingblog.com. He also authored the 1999 book Riding The Bear – How To Prosper In the Coming Bear Market.