Stormy Summer Ahead
Seasonality says stay out of the pool.
I'm not a big seasonality guy, but one of the measures I follow is a Seasonality Index created by Jay Kaeppel.
The Index looks at several seasonal factors (exchange holidays, month-end tendencies, "Sell in May..." and the presidential cycle) and assigns each day a score whenever one of them is present. If none are applicable, then that day gets a score of "0." If all of them are present, then that day gets a "4." The higher the score, the better the chance for the market to rise.
This has become increasingly interesting to me since we're about to enter a long string of "0" days. This will be the first time since the summer of 2006 - a tough time for the market - that we've seen that.
We can check to see how this would have worked during the history of the S&P 500 tracking fund (SPY). During its lifetime, SPY has gained just under 95 points. Let's break that down by how many points it accumulated during each of the differently-scored days (the average return per day is in parentheses):
- Seasonality Index = 0: -29 (-0.1%)
- Seasonality Index = 1: +5 (+0.0%)
- Seasonality Index = 2: +73 (+0.1%)
- Seasonality Index = 3: +46 (+0.2%)
- Seasonality Index = 4: -2 (-0.1%)
From the scorecard above, we can see that the S&P performed pretty much in line with the scores - the lower the score, the lower the average return. The one deviation is "4" days, supposedly the most bullish of all, which actually proved to have a negative return. The reason is that there were very few of them (11 in total), and one day skewed the results. 8 of the 11 showed a positive return, but one bad boy of -1.6% in 1999 ruined the overall positive expectancy.
If you had been invested just on days scored "2" or "3", you would have gained about 120 points in SPY with a maximum drawdown of 25 points. That compares to a buy-and-hold gain of 95 points with a 75-point max drawdown. Clearly, paying attention to the Seasonality Index would have made a huge difference.
Of course, that means a lot of trading, which would drastically reduce the results if you include slippage and commissions. I'm not trying to put forth a trading system here: Rather, I want to see whether it would have paid to be more bullish on some days than others, and that seems to be the case.
For the Nasdaq 100 trust (QQQQ), the results were equally dramatic. Here's the breakdown by score:
- Seasonality Index = 0: -30 (-0.1%)
- Seasonality Index = 1: -26 (-0.0%)
- Seasonality Index = 2: +35 (+0.1%)
- Seasonality Index = 3: +15 (+0.3%)
- Seasonality Index = 4: -1 (-0.2%)
If you had been invested only on "2" or "3" days, then you would've gained a total of 52 points in QQQQ, with a maximum drawdown of only 18 points. If you had bought and held QQQQ since inception, then we would have shown a loss of 3 points with a maximum drawdown of a whopping 98 points.
Is the upcoming string of "0" days a cause for concern? I believe it is, based on the data above.
That means that I will be looking to take more aggressive short-side positions when the setups exits, and lighten my exposure to the long side in a general sense. Seasonality is a tertiary indicator to me, but it does influence my trading, especially in terms of trade sizing.
Going back to 1950 and using the S&P 500 cash index, if we had bought the index when it hit a "0" day and sold it when it hit a "2" or higher, while the 200-day moving average of the S&P was sloping downward at the time (like it is now), then we would have had only 40% successful trades, with an overall average return of -1.1%. The average maximum drawdown during those periods was 55% higher than the average maximum gain.
The Seasonality Index will be primarily "0" through October of this year.
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