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 below. You don’t need to read the rest of this article.
For those of you who do know about annual seasonality, the fall signal to buy has been triggered. A bit of a mea culpa is in order here, as the signal actually came several days ago — we haven’t focused on this signal for many years now and unfortunately I missed it until this weekend. (On the positive side, "normal" annual seasonality wouldn’t have an investor buy until the end of this month, so this is still getting in early from that standpoint.)
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 “This Year’s Signal” 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 was triggered a few days ago.
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 developments
Crucially, it’s important to note 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 (most recently the six-month period that ended October 2018 and that will come around again next year).
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 unusually favorable period is the six months immediately after the mid-term elections (the favorable period that will begin in November 2022).
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 another 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 among six asset classes at any time during the year, irrespective of the annual seasonality cycle. Put bluntly, DAA has done a better job of determining when to increase and decrease a portfolio’s allocation to stocks than annual seasonality has.
When comparing owning stocks while applying annual seasonality and 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 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 than annual seasonality regarding when to be invested in stocks and when to be out of them.
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, in contrast, is purposely designed to give us more specific signals. It also 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 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 continue to report on the annual seasonality timing signals, as we know there are members who use it within their 401(k) accounts where implementing DAA really isn’t an option. But hopefully, we’ve illustrated why there are better options for most readers than annual seasonality for adjusting risk.
This year’s signal
When the annual seasonality sell signal triggered in May, we suggested it was probably a bad idea to follow through and sell stocks. That has proven to be accurate as stocks have continued modestly higher throughout the summer months. The broad market indexes are roughly +7% higher than they were on May 4 when that article was posted.
With all of the relevant signals from SMI’s other strategies (such as DAA) indicating that stocks are the place to be and that risk opportunities are widening (small stocks looking better, value looking increasingly attractive relative to growth, a broadening array of energy and financial funds climbing the sector rankings), there’s plenty of confirmation for this signal to get back into stocks. Or to stay in them if you never left, which is hopefully the case for most of those who have read this far!
Conclusion
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 right now 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 the MACD signal (because it’s not part of your long-term plan), we don’t advise taking any action based on this signal.
