Our tastes are seasonal. As winter approaches, we eat less salad and fish and more stews, and I for one listen to less swamp pop and more Leonard Cohen and Townes Van Zandt. What’s true of music and food is also true of appetite for risk. This increases in the spring but declines as the nights draw in: for centuries, May Day has been a celebration of hope and optimism whilst Halloween marks fearfulness and anxiety.
All this is obvious. And it has an obvious implication – that stock market returns are seasonal. As the nights draw in and anxiety rises, prices fall too far to levels from which braver investors are well-rewarded for taking risk. And as the nights get lighter in the spring, so prices rise as optimism increases. This year’s events – with markets surging in April and May and falling in October – fit this pattern like a glove.
This helps explain my chart. Shares tend to do well (on average of course) in December and January, because they were too low in the autumn. And they rise strongly in April as optimism increases. That however leaves them over-priced, which means returns in the summer months are mediocre.
But here’s the thing. Mention this to most investors, whether amateur or professional, and they’ll think you a crank. This isn’t for want of evidence. Ben Jacobsen and Cherry Zhang have shown that the “buy on May Day, sell on Halloween” rule has worked in almost all stock markets since data began*. I obey this rule myself: I transferred some of my pension from a money fund into an All-share tracker this morning.
There is infinitely more evidence for a Halloween effect in stock markets than there is for the idea that conventional stock-picking works. And yet talk of a seasonal pattern in returns marks one out as a loon, whilst active managers are Very Serious People.
In fact, there’s another example of this. We have tons of evidence that momentum investing works. And yet few fund managers act upon this – although there are many ETFs which claim to exploit the phenomenon. Not many tell their clients: “we’ve bought these stocks simply because they’ve gone up a lot.”
What we have on both these cases is a massive disjunct between what’s credible and what has an evidence base. Halloween or momentum investing have empirical justification but no credibility; conventional active management has credibility but little (pdf) empirical base.
This tells us two things. One is that evidence-based policy-making isn’t necessarily cold technocracy. In finance, evidence-based activity can be a radical challenge to the Establishment.
It also reminds us that finance is ideological. There’s a good reason why there’s so much resistance to the Halloween and May Day indicators. Fund managers are selling an image. They want to pretend that they are sober hard-headed men who can be entrusted with out money. Stock market seasonality undermines this self-image by showing that their decisions are swayed not merely by cold facts but by the same atavistic swings in sentiment to which stone age men were prone.
As Alasdair MacIntyre wrote in After Virtue, claims to expertise are also claims to power. Sometimes the facts undermine those claims: It’s for this reason that there’s as much hostility to the Halloween indicator as there is to index funds. As Upton Sinclair famously said, “it is difficult to get a man to understand something, when his salary depends on his not understanding it.”
* Yes, the effect is larger in the northern hemisphere than south. In New Zealand there’s no difference between returns from Halloween to May Day and from May Day to Halloween. And in Australia the difference is a below-average two percentage points. We’d expect some positive difference simply because markets are globalized, so Aussie stocks are pushed up and down by northern ones.
Another thing. You might think that investors should by now have wised up to seasonality, and thus eliminated it. They obviously didn’t do so this year. And there might be a reason why not. Think of stock markets as being like Keynes’ famous beauty contest. The more aware people become of seasonality, the more they might worry in the autumn that others will become anxious. (Or worry that others will worry that others will worry, and so on). If so, they’ll drive prices down even if they themselves don’t feel nervous. Equally, they might buy in the spring in the hope that others will have seasonal risk appetites. In this way, knowledge of an apparent anomaly can cause it to persist or even increase.