Stock Seasonality Strategy: Consistency Leads to Long-Term Success

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Stock Seasonality Strategy: Consistency Leads to Long-Term Success

Long-time readers may recall our previous coverage of the stock seasonality strategy-based portfolio. It’s one of our favorites because it demonstrates how consistently adhering to a relatively simple strategy over time can produce market-beating results:

In this newsletter, we revisit this portfolio to review its performance and explore its extensions. We will also use our new rolling returns-based metrics to compare it with the S&P 500 index fund.

Seasonality portfolio background

It is worthwhile to first understand the background of this strategy, commonly referred to as “Sell in May and Go Away.” Interestingly, this strategy has been recognized for at least 40 years, if not longer. An academic paper on this topic was published in the reputable research journal “American Economic Review” in 2002, 22 years ago.

The underlying idea behind this strategy is that stocks tend to perform strongly from October to May. By avoiding investments during the summer months, one can still achieve comparable returns while minimizing exposure to the typically more volatile market conditions of this period. This approach can also help reduce risk.

It is generally well recognized that October 16 is the optimal day to enter the stock market for the upcoming favorable seasonal period, and April 20 is the best day to exit this favorable season.

However, it is important to note that the market does not consistently begin a rally or decline on the same days each year. For this reason, the strategy has been refined by using the MACD indicator to determine precise buy and sell days.

Entry and Exit Rules:

Entry Rule: After October 16, you should not enter the stock market until the MACD triggers a buy signal.
Exit Rule: After April 20, you should not exit the stock market until the MACD triggers a sell signal.

The MACD used can be found in the MACD Strategy section. Essentially, this strategy involves staying in cash or bonds from May to October, with a technical MACD indicator used to determine the exact timing. The intuition behind this is that you will enter and exit based on a technical indicator when you are in the supposedly favorable period from October to April.

The STS Seasonal Timing Using VFINX Total Return Bond Fund As Cash portfolio employs Schwab Total Return Bond as a cash equivalent. When the strategy signals a move to cash, it switches to a total return bond portfolio such as Schwab Total Return Bond . Otherwise, it invests in the S&P 500 index fund VFINX.

Outperforming S&P 500

It’s widely accepted that once a profitable strategy becomes public, it tends to underperform as investors and traders start to front-run it. The seasonality strategy was well-known in the 1990s, so if this belief holds true, it should have underperformed entering the 21st century. Let’s examine whether that actually happened:

STS Seasonal Portfolio vs VFINX (as of 8/9/2024):

Ticker/Portfolio Name	Max Drawdown	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	20Yr AR	Since 1/2001
STS Seasonal Timing Using VFINX Total Return Bond Fund As Cash	34%	10.4%	15.4%	8.1%	11.0%	10.4%	12.7%	11.1%	10.3%
VFINX (VANGUARD 500 INDEX FUND INVESTOR SHARES)	55%	12.9%	21.2%	7.9%	14.6%	12.7%	13.8%	10.4%	8.2%

The following are the MyPlanIQ Proprietary portfolio and fund ranking metric scores:

STS Seasonal Timing Using VFINX Total Return Bond Fund As Cash: Fund Score = 0.12
VFINX (VANGUARD 500 INDEX FUND INVESTOR SHARES): Fund Score = 0.04

10-Year Rolling Return Chart

15-Year Rolling Return Chart

Since 2001, this strategy has delivered better returns overall, although it has lagged behind VFINX (S&P 500) since the 2008 low. In fact, if we examine the 10-year rolling chart, we can see that this strategy outperformed VFINX for any 10-year period between 2001 and 2018. However, it has consistently underperformed VFINX’s 10-year rolling return since 2018 (reflecting the 10-year periods following 2008). This is understandable, given that U.S. stocks have been in a super bull market since 2009. A similar pattern is observed with 15-year rolling returns, where VFINX began to outperform this strategy for 15-year periods starting at the end of 2007.

Furthermore, this strategy successfully avoided some of the worst months during the 2001-2003 tech bubble and the 2008-2009 financial crisis, resulting in a maximum drawdown that was only two-thirds of the S&P 500’s.

We can see that this strategy indeed defied the popular belief for certain periods, even after it became well-known. While it remains to be seen whether the current underperformance since 2009 will persist, it’s highly likely that it will outperform again in the years to come.

Seasonality in other stock and balanced funds

Let’s extend our examination beyond the S&P 500 index fund. The following tables show two additional portfolios: one applying the seasonality strategy to the VPMCX (VANGUARD PRIMECAP FUND INVESTOR SHARES), and the other applying it to the PRWCX (T. ROWE PRICE CAPITAL APPRECIATION FUND).

The Vanguard PrimeCap Fund (VPMCX) is one of the top-performing stock funds based on our fund ranking metric (we’ll discuss this in more detail in a future newsletter), while the T. Rowe Price Capital Appreciation Fund (PRWCX) has been nicknamed by us as the “best” balanced fund. Both funds are the best in their respective categories.

It turns out that the seasonality strategy works very well with these two funds as well.

Seasonality VPMCX vs. VPMCX (as of 8/9/2024)

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	20Yr AR	Since 1/2001
STS Seasonal Timing Using VPMCX Total Return Bond Fund As Cash	8.8%	13.9%	6.8%	11.0%	10.2%	12.6%	11.6%	11.3%
VPMCX (VANGUARD PRIMECAP FUND INVESTOR SHARES)	9.1%	16.9%	6.7%	13.9%	13.0%	14.4%	12.1%	9.8%
VFINX (VANGUARD 500 INDEX FUND INVESTOR SHARES)	12.9%	21.2%	7.9%	14.6%	12.7%	13.8%	10.4%	8.2%

Seasonlity PRWCX vs. PRWCX (as of 8/9/2024):

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	20Yr AR	Since 1/2001
STS Seasonal Timing Using PRWCX Total Return Bond Fund As Cash	6.3%	10.5%	5.4%	8.3%	8.8%	11.2%	11.1%	11.1%
PRWCX (T. ROWE PRICE CAPITAL APPRECIATION FUND)	7.5%	13.6%	5.7%	10.9%	10.6%	11.7%	10.1%	10.1%

We also observe similar outperformance in terms of rolling returns and reduced maximum drawdowns.

In fact, this phenomenon can also be extended to a stock portfolio.

Summary

The above exercise is not intended to advocate for the seasonality strategy but rather to illustrate that some anomalies in financial markets can persist for a long time, even after becoming well-known. While there may be various explanations for this persistence, such as the difficulty of frequently switching between stocks and bonds, tax efficiency considerations, or the general inconvenience, another key reason is that when a strategy underperforms for an extended period, investors or traders are often quick to abandon it, only to see it eventually regain its outperformance.

For tax reasons, one can consider utilizing this strategy in a tax-deferred account, such as a 401(k) or an IRA.

Market Overview

Now that the earnings report season is nearing its end, as of last Friday, FactSet reports that for Q4 2024, with 91% of S&P 500 companies having reported results, the blended year-over-year earnings growth for the S&P 500 was 10.8%. This exceeds the blended growth of 9.8% two weeks ago and also surpasses the 8.9% expected as of June 30, 2024, by nearly 2%.

Stocks experienced a sharp dip in the last two weeks due to unexpected news about tightening in the job market. They have since recovered somewhat. However, it remains to be seen whether the economy will slow down significantly and if the Federal Reserve will be too late in cutting interest rates to ease financial conditions.

At the moment, it is widely expected that the Fed will lower interest rates in September.

As always, we claim no crystal ball and we call for staying the course which is guided by well-defined and sound strategic and tactical strategies:

For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as we have emphasized numerous times when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years, preferably much longer, given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. If you are comfortable with this thesis, you should sit tight and forget about the current gyration.
For tactical investors, again, you have to ignore the current market noise. Also, you should follow your strategy rigorously, especially during this time. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This is true time and time again.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of market is through dollar cost average (DCA), i.e., invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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