This post has the potential to be confusing, especially for newer readers. So let me begin by saying that if you don't know what the term "annual seasonality" means, you can safely ignore everything written here.
For those of you who do know about annual seasonality, the fall signal to buy has (surprisingly) been triggered.
I’m going to repeat some background about annual seasonality, then turn to the specifics of this particular signal. (If annual seasonality and MACD are old-hat to you, skip down to the “Recent Developments” heading below.)
Annual seasonality background
As this Introduction to Annual Seasonality explains, the stock market has historically performed much better on average between November-April than between May-October. This is, of course, an average based on many years of observation, and any specific year can vary dramatically from that long-term trend. But it is a pattern that has persisted long enough, and across global markets as well as here in the U.S., so as to have attracted quite a bit of attention over the past few decades.
The basic idea of annual seasonality, then, is to sell stocks at the end of April and buy back in at the end of October. Taking this idea a step further, some researchers have shown that using a short-term timing signal, called MACD (Moving Average Convergence Divergence), to fine-tune the exact buying and selling dates boosts the overall returns of utilizing the annual seasonality idea dramatically. SMI has been tracking this approach for the past 15 years or so, as explained in Adding MACD to Seasonality. This MACD signal is the buy signal that has been triggered.
It’s important to point out that annual seasonality has always been an optional refinement to SMI’s strategies. Most SMI readers have not utilized annual seasonality in building their long-term investment plans.
Recent developmentsCrucially, it's important to note there have been two significant developments in recent years that have led us to significantly downplay the importance of these annual seasonality signals.
First, our investigation of the impact of the election cycle on annual seasonality found that there is actually only one unfavorable period (out of a total of four May-October periods) during which stocks have, on average, lost money. That is the May-October period leading up to the U.S. mid-term elections (the six-month period that just ended yesterday). Ironically, stocks went up through most of that "bad" period this year, although October's losses had knocked them back to the April 30 level as of just a couple days ago. The last two days pushed this normally "bad" period as a whole to a very small gain.
There’s also only one favorable period (out of four November-April periods) that is substantially better than the others (though the favorable periods of all four years have done well). This one unusually favorable period is the six months sitting immediately ahead.
Translation: based on annual seasonality, as viewed through this election cycle lens, there’s really only one six-month period out of every four years when you’d want to do anything other than own stocks.
Given that, even those who want to apply annual seasonality as part of their investing plan would have a compelling case to alter their base asset allocation only during the unfavorable period of each mid-term election year (and possibly the following favorable period — see the charts in the previous link which show this quite vividly).
The second significant development and reason to question the value of continuing to apply annual seasonality signals stems from our Dynamic Asset Allocation research. DAA already has a timing element built into it that triggers changes between six asset classes at any time during the year, irrespective of the annual seasonality cycle. Put bluntly, DAA has done a much better job of determining when to increase and decrease a portfolio's allocation to stocks than annual seasonality has.
When owning stocks while applying annual seasonality is compared to simply owning stocks year-round, it’s easy to make an argument in favor of incorporating the annual seasonality modification. However, when comparing the relatively blunt-instrument approach of annual seasonality to the more specific signals generated by Dynamic Asset Allocation, the results aren’t even close. Dynamic Asset Allocation has provided much better signals of when to be invested in stocks and when to be out of them than annual seasonality.In some respects, this is an unfair comparison. Annual seasonality was never held out as a finely honed scalpel. It’s a blunt, simple device to improve on buy-and-hold stock market investing. DAA is purposely designed to give us more specific signals and it requires a lot more — namely, calculating and tracking the momentum scores and potentially altering one's allocation every single month instead of just twice a year.
But for the SMI premium-level member, the issue is quite a bit simpler. The DAA information is available to you every month in an easy-to-obtain format (just sign up for e-mail updates or visit this DAA page at the end of each month). Given that these signals have been better historically than annual seasonality’s, and they are so easy for SMI readers to obtain, it’s hard to imagine why someone would continue to use the blunt instrument approach of annual seasonality any longer.
This is a good illustration of DAA superseding some of our past advanced strategies. Annual seasonality was helpful until we found something better. Now that we have, we encourage you to use it instead.
We’ll continue to report on the annual seasonality timing signals, as we know there are members who use it within their 401(k) accounts where DAA really isn’t an option. But hopefully we’ve illustrated why, for most readers, there are better options than annual seasonality for adjusting risk.
This year's signal
First of all, I confess that I was really surprised the signal triggered yesterday. With the degree of October's stock market downturn, and the fact that as recently as Monday of this week the market still looked like it could be falling apart, it's pretty surprising to get a signal this quickly. That said, the S&P 500 index is up 127 points from Monday afternoon's lows, a gain of nearly 5%. And MACD is a quick reacting indicator, particularly on the buy side, so when we're using it in the way annual seasonality does (where we're already predisposed to an action and just looking to fine-tune the timing), it doesn't take a lot to trigger it.
Let me translate that last sentence another way: I wouldn't read too much into this signal.
This market is still on pins and needles. I don't think anyone is going to feel comfortable until next week's election is behind us and stocks are moving higher again.
It's crucial to understand that MACD is not a particularly robust timing indicator. It's an extremely short-term indicator that really is useful only for optimizing a decision to buy or sell that has been made already. In other words, you shouldn't depend on this signal to determine whether it's a good idea to buy stocks or not — but in a system like annual seasonality where the decision to buy sometime around 10/31 already has been made, it can be a useful aid in fine-tuning the date to buy.
Again, to be clear: if you haven't been specifically looking for this signal (because it's not part of your long-term plan), we don't advise taking any action based on this signal.