When considering whether to put your money into a new business, what do you need to make informed decisions? For sure, an extensive research of the company, sector and market are a good place to start. However, investors often look for extra factors to give them the ‘edge’. Are there such things as a best month or time of the year to invest in a new business?
What the old adages say…
"Sell in May and go away" is an age-old investment adage, referring to the traditional belief that stocks show weaker performance in the summer, from May to October, and stronger performance in the winter, from November to April. According to this saying, you should disinvest in spring - just before the summer lull - and invest in autumn - just before the market picks up again. This is sometimes also called the "Halloween indicator".
There is a good deal of truth to this. A study by the American Economic Association showed that this pattern held true in 36 of 37 developed and emerging markets studied globally, and was particularly strong in Europe. The paper noted evidence for it in the UK stretching back to 1694.
This effect may be caused by seasonal fluctuations in optimism among investors.
Some other well-known theories include the “January effect”, the “October effect”, and the “Santa Claus rally”. There has even been research done on the effect of the “unlucky sevens”! This refers to the years 1987 and 1997, when equity markets experienced sharp downturns.
The “January effect”, also called the “year-end” effect, refers to the conspicuous rise of equity markets during the period starting the last day of December and ending the fifth trading day of January. One reason for the “January effect” could be due to corporations and individuals closing their tax books at the end of December. People sitting on paper losses are more willing to sell out their investments to create a tax-loss situation. The other reason for selling investments in December is to raise cash for the holidays.
Because both of these reasons may contribute to a market sell-down in December, bargain hunters tend to start buying at the beginning of the following year, causing some form of market frenzy during the early part of January – hence the “January effect”.
Equally, December’s “Santa Claus rally”, is a similar boost that has been linked to holiday-season optimism (and Christmas bonuses).
According to a study based on MSCI Asia ex–Japan Index as a proxy for the Asian market, S&P 500 Index as a proxy for the U.S. market, DJ Stoxx 50 Index as a proxy for the European market, Nikkei 225 Average as a proxy for the Japanese market and the Singapore’s Straits Times Index (STI), December posted the strongest average return while August turned out to be the worst month in terms of the average returns. Based on these data, if you had invested in our basket of five indices during August, you would have lost 1.5% of your investments. On the other hand, you would have made 2.5% if you invested in December.
And what is the truth?
So, what can we get from that? Is there really a better time of the year to invest?
It looks like that “Selling in May” is not what people actually do. US and Canadian researchers found that investors are more bullish in spring and cautious in autumn. In the study, the authors looked at how money flows among different categories of mutual funds to find that people are more likely to buy risky assets in warmer months, but are more risk-averse in later in the year, more likely to sell higher-risk assets to buy safer ones.
The “seasonal mood cycle” of investments
The origin of this seasonal mood cycle may lie in the seasons themselves. Some economists argue that fluctuating temperatures, day length and sunlight levels over the course of the year can sway investor behaviour and so move markets.
If many investors become more cautious when it’s dark outside and returns are generally lower for cautious investments, why should overall returns then rise in winter?
Because when the cautious investors sell their riskier assets in autumn, the price drops, meaning quality investments can be scooped up for a low price by those willing it to take the risk. Since these quality investments were bought at a bargain, the returns are disproportionately high when the market eventually bounces back at the end of winter, boosting overall returns.
Second, and more importantly, seasonality is only one of many, many factors affecting the stock market. Returns in a given year may deviate substantially from seasonal patterns.
In conclusion, those looking for investment guidance are better off ignoring the thermometer and calling a qualified financial adviser instead.