Seasonal Timing Strategy™ (STS).

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Market Timing! Stocks! Short Sales! Mutual Funds! Bonds! Gold! Street Smart Commentary!



STREET SMART REPORT ONLINESy Harding www.StreetSmartReport.com
Market Timing! Stocks! Short Sales! Mutual Funds! Bonds! Gold! Street Smart Commentary!
From: Asset Management Research Corp. Our 22nd year of providing research to serious investors!

Our long-time proven Seasonal Timing Strategy™ (STS).
Occasionally we read funny comments about our Seasonal Timing Strategy.
Introduced in 1998, over the last ten years our STS has gained more than 7 times as much as the Dow, and much more than that compared to the S&P 500 and Nasdaq. In fact, its gain over the last 10 years can't even be calculated as a multiple of the gains of those two indexes, since they both had no gains, actually lost money over the last ten years.
For years our subscribers have been raving about what our STS has done for their financial health, as well as their mental health (by avoiding the stress of periodic large losses), and passing the word along to their friends and relatives.
But sometimes a non-subscriber thinks he or she has discovered a flaw, and says, "Your STS doesn't work. It under-performed the market in 2003 and in 2006." A few financial columnists have also written that "The market's seasonal pattern is an iffy thing. Sometimes it doesn't work."
Those are silly observations, apparently given with no thought or analysis.
So, let's us give those observations some thought. The following table shows the real-time performance of our Seasonal Timing Strategy over the last 10 years. That includes 6 years of bull market, and 4 years of bear market, so favors buy & hold. Yet the market-timing provided by the seasonal strategy blew away the performance of the market on a buy & hold basis.
That is true whether one looks at a 1 year, 3-year, 5-year, or 10-year performance comparison.

YEAR
NASDAQ
S&P 500
DJIA
STS using DJIA Index Fund
1999 (Bull Market)
+ 85.6%
+ 20.1%
+ 26.8%
+ 35.1%
2000 (Bear Market)
- 39.3%
- 9.1%
- 4.6%
+ 2.1%
2001 (Bear Market)
- 21.1%
- 11.9%
- 5.3%
+ 11.1%
2002 (Bear Market)
- 31.5%
- 22.1%
- 14.7%
+ 3.1%
2003 (Bull Market)
+ 50.0%
+ 28.7%
+ 27.6%
+ 11.2%
2004 (Bull Market)
+ 8.6%
+ 10.9%
+ 5.5%
+ 8.1%
2005 (Bull Market)
+ 1.4%
+ 4.8%
+ 1.6%
+ 0.6%
2006 (Bull Market)
+ 9.5%
+ 15.4%
+ 18.5%
+ 14.2%
2007 (Bull Market)
+ 9.8%
+ 5.4%
+ 8.6%
+ 11.2%
2008 (Bear Market)
- 40.5%
- 36.1%
- 31.3%
- 3.6%
Data includes dividends and interest on cash.

10 -Year Return
- 28.0%
- 13.2%
+ 17.9%
+ 132.5%
5 - Year Return
- 21.2%
- 9.6%
- 5.2%
+ 47.2%
3 - Year Return
- 28.5%
- 22.3%
- 11.6%
+ 22.4%

Our Aggressive STS portfolio was up 3.2% in 2008. Our non-seasonal Market-Timing Strategy portfolio was up 9.2% for 2008.

Yes, it's true that STS did not outperform the market in 2003 or 2006. But you know what? There is no strategy that beats the market in every individual year.
That certainly includes a buy & hold strategy. Just look at the individual years (2000, 2001, 2002, 2008) when 'buy & hold' not only did not out-perform the market, but had serious losses.
Yet when STS under-performed the market in 2003 and 2006 it still made double-digit gains.
In fact, in the last ten years STS had only one down year, 2008, and it was down all of 3.6%, in the worst bear market year since 1931. It was a year in which even the conservative Dow was down 31.3% (with dividends added back to lessen its actual decline).
Yet in the great bull market bubble year of 1999 our STS strategy also outperformed both the Dow and S&P 500.
How's that for outstanding performance in all kinds of markets? (And with considerably lower risk since it's only in the market four to seven months a year).
Even 'best investor in the world' Warren Buffett has numerous individual years of large losses. But not STS, at least not in 50 years (40 years of back-tested data, and ten years of real-time use in our newsletter).
As shown in the following chart, the holding company for Buffett's investments, Berkshire Hathaway, declined 49.7% from its 1999 peak, and it was almost 5 years before it was back to even. It had other fairly serious declines of up to 19% even in the new bull market that began in 2002. And it was down as much as 48% in the 2007-2008 bear market, about the same decline as the market itself at the November, 2008 low. And like the market it went virtually nowhere over the last 11 years on a buy and hold basis, at one point in 2008 being back approximately to its level of 1998. And that's with the superior stock-picking ability of Warren Buffett.
You don't hear much in the media about that kind of painful volatility when they are touting Buffett's performance.


The correct observation regarding STS in 2003 and 2006, was that the strategy did not out-perform the market in those individual years, but it still made double-digit gains in those years. And of course its outstanding long-term performance included those two years when it 'under-performed'.
However, when a buy and hold investor, or a follower of any other strategy, has an under-performing year it is not a case of merely making a decent but smaller profit, but of suffering significant losses, which then often require years to get back to even.
While the yellow table above shows the parallel performance over the last 10 years of the Dow, S&P 500, and Nasdaq compared to STS each year, as they say a picture is worth a thousand words. The next chart shows visually how the market performed for buy and hold investors over the same period.
After its exciting rip-roaring bull market bubble years of 1997-2000, which had everyone clamoring to buy even more excitedly near the top, the market took back virtually all of the 'bubble' years gains in the 2000-2002 bear market. It then recovered in the 2002-2007 bull market just in time for the current bear market, which took back all the gains again.
Unusual to have two bear markets in 10 years? Over the last 100 years there have been 24 bear markets or one on average of every 4.1 years.


Obviously what is needed is a strategy that works in both bull and bear markets. And our STS has certainly proven that it is such a strategy. We know of nothing that touches it for performance, or for its risk management (which is an important portion of successful long-term investing).
The background:
Previous research on seasonality, which led to the well-known, but flawed, market slogan 'Sell in May and Go Away', was very generalized. It indicated that the market’s pattern of favorable seasonality begins October 1st, (based on the 1980s research of Ned Davis Research Inc.), or November 1st (based on the 1980s research of the Hirsch Organization), and ends May 1. However, the intention of both researchers was only to determine whether the market moves in recognizable seasonal patterns, and they apparently used month-end data to make that determination.
It was our intention to develop the market’s seasonality into a specific investment strategy, one that would work in both bull and bear markets, so it could be offered in my 1999 book Riding the Bear – How to Prosper in the Coming Bear Market, as the strategy that would allow an investor to continue making gains in the 1990s bull market, and to keep those gains, and then make more in the severe bear market our work was telling us to expect.
We began by back-testing a hundred years of market data, with the goal of determining the exact days of the year, rather than the month, that on average would produce the best entry and exit dates for investing according to the market’s seasonality.
We discovered that those best days on average are October 16 for the entry into the market for its favorable seasonal period, and April 20 for the exit from the market’s favorable season. However, those are just the best days as averaged over a very long time period. Obviously the market does not begin a rally on the same day each year, or begin to decline from a top on the same day each year. And recognition of that obvious fact is the most important aspect of our strategy.
So we then concentrated on determining a means by which the entries and exits could be more accurately pinpointed for each individual year.
The result was our Seasonal Timing Strategy, or STS.
Since the market does not begin or end its positive period on the same day each year, we combined the market’s best average calendar entry and exit day with a technical indicator, the Moving Average Convergence Divergence indicator, or MACD. It is a short-term momentum-reversal indicator developed by Gerald Appel in the 1980s, designed to signal when the market has begun either a short-term rally, or a short-term correction.
The idea is that if a rally is underway when the October 16 calendar date for seasonal entry arrives, as indicated by the MACD indicator, we will enter at that time. However, if the MACD indicator is on a sell signal when the October 16 calendar date arrives, indicating a market decline is underway, it would not make sense to enter before that decline ends, even though the best average calendar entry date has arrived. Instead, our Seasonal Timing Strategy simply waits to enter until MACD gives its next buy signal, indicating that the decline has ended.
We use the same method to better pinpoint the end of the market’s favorable period in the spring. If MACD is on a sell signal when the calendar exit day of April 20 arrives, we exit at that point. However, if the technical indicator is on a buy signal, indicating the market is in a rally when April 20 arrives, it makes no sense to exit the market just because the calendar date has arrived. So our Seasonal Timing Strategy’s ‘exit rule’ is to simply remain in the market until MACD triggers its next sell signal indicating the rally has ended.
Using this strategy we are able to take advantage of the fact that although the market’s favorable and unfavorable seasonal periods average approximately six months each, they actually vary significantly from year to year, sometimes being as brief as four months, other times lasting as long as seven months.
The following chart demonstrates our Seasonal Timing Strategy applied to the DJIA, and how well it worked even in the strong bull market years of 1997-1999, to have investors in for the 'favorable' seasonal periods when the market usually makes most of its gains each year, and out for the 'unfavorable' seasonal periods when the market tends to suffer most of its declines (whether it is in a bull or bear market).
Thus did it not only make good gains in the bull market years, avoiding intermediate-term corrections, but also avoided the big declines in the bear market years of the 2000-2002 bear, and the 2008 bear, as by far the most severe portions of bear market declines also take place in the 'unfavorable' seasons, while bear market rallies tend to take place in the favorable seasons.

The chart shows the action of the DJIA from mid-1997 to mid-1999, which encompasses two of the market’s favorable seasonal periods. The lower window of the chart shows the DJIA itself, while the upper window shows the MACD indicator.
The vertical lines are the calendar entry days of October 16, and the calendar exit days of April 20 the following year.
Note at the left end of the chart that when October 16, 1997 arrived MACD was on a sell signal. The entry rule of STS is that we are not to enter until MACD triggers its next buy signal. As indicated by the up-arrow that did not take place until mid-November.
When April 20 of 1998 arrived, MACD was on a buy signal. The STS exit rule is that we therefore are not to exit until MACD triggers its next sell signal, which in this case was just a few days later, and actually at a lower price than had we used the calendar date.
Moving on to the entry in the fall of 1998, when October 16 arrived, the earliest entry date acceptable to STS, the MACD indicator was already on a buy signal, so we would enter at that point.
However, when the exit date of April 20 arrived the following spring MACD was on a buy signal, meaning the exit would be postponed until MACD triggered its next sell signal. That did not occur until mid-May, providing almost an extra month of higher prices before STS signaled that the market’s favorable seasonal period was over.
Note that MACD, like the calendar dates, does not get an investor in at the exact bottom in the fall, nor out at the exact top in the spring. No strategy could possibly do that. But MACD does most often provide a better entry and exit than simply using the calendar, and produces market-beating gains over the long-term by avoiding most serious market corrections and then getting back in at a lower level.
Since risk management is an essential part of money management it’s also important to note that seasonal investing also completely avoids individual stock risk, and sector risk, and even significantly decreases market risk, by only be in the market roughly half the time, and safely earning interest on cash during the highest risk period (the market's unfavorable season).
I introduced STS publicly in my 1999 book Riding the Bear - How to Prosper in the Coming Bear Market.Yale and Jeff Hirsch reported in their newsletter;
"We applied Harding's system, which he developed based on the Dow's seasonal pattern, to the S&P 500. The results were astounding!" Smart Money, July, 1999
They also included the following in their year 2000 edition of The Stock Traders Almanac.
"Tested over the last 51 years, the strategy more than doubled the already outstanding performance of the basic 'Best Six Months' seasonal strategy."
Bloomberg Personal Finance Magazine reported;
"Remarkably simple but also remarkably profitable, at least in the hands of a disciplined practitioner like Sy Harding, editor of StreetSmart Report.com."
What Creates the Seasonal Pattern?
Why would the market move in such consistent seasonal patterns regardless of the surrounding economic and political conditions?
The driving force is the same force that creates all sustained market moves, a change in the amount of money flowing into the market. Just as the extra money that flows into the market at the end of each month creates the short-term ‘monthly strength period’, so significant changes take place in the amount of money that flows into the market in pre-determined patterns in the fall and spring months, which produces the annual seasonal pattern.
As the market enters the fall season, investors begin receiving large chunks of extra cash most of which is automatically invested in the market. For instance, most mutual funds have fiscal years that end September 30 so they can get their books closed and make their capital gains and dividend distributions to their investors in November and December. Most mutual fund accounts are marked for automatic re-investment of dividends. Additionally, third and fourth quarter dividend distributions from corporations are paid to investors in the period between November and March. Most dividends are marked for automatic re-investment. Employers make their contributions to employee profit-sharing plans, and year-end contributions to their employees’ 401K and pension plans. Those are automatically invested in the market.
Then there are Christmas bonuses, year-end bonuses, income tax refunds in the spring, etc. Highly paid hedge-fund managers collect their large year-end fees at the end of the year. Small business owners close their books at the end of each year, and by February or March their accountants let them know what their profits were, and they then distribute those profits to themselves.
And much of that extra cash finds its way into the stock market.
Wall Street institutions, money-management firms, and knowledgeable investors, aware of the market's seasonal tendency, also begin buying more heavily, often in October, in anticipation that the market will make its usual impressive gains in the favorable season.
However, in the spring of the year that huge flow of extra money into the market dries up, with income tax refunds being the final act.
That creates a sizable decrease in buying pressure, which allows whatever selling there is to have more influence on the direction of the market. It also deprives mutual funds and investors of the extra money needed to buy the dips, which might otherwise prevent a market decline from taking place.
In addition, Wall Street institutions, money-management firms, and knowledgeable investors, aware of the frequent effect of the market's unfavorable season on stock prices, take profits from the favorable season and lighten up on holdings for the summer months. Interest in the market also diminishes significantly as many investors and traders go off on vacations. That can be seen in the way trading volume dries up significantly during the ‘summer doldrums’.
Thus does the market tend to make most of its gains each year in the favorable seasonal period when hundreds of billions of dollars of extra money flow in, and suffer most of its losses in the unfavorable seasonal period when that extra fuel dries up, and is not there to offset any selling pressure that develops during the unfavorable season as a result of bad news or economic conditions.
Seasonality is also the answer to the age old question of why the stock market is sometimes able to ‘climb a wall of worry’ (shrug off bad news), while other times it seems unable to rally even on good news. It is simply that when large amounts of extra money are flowing in during the favorable season, the market is able to rally no matter that surrounding news may be negative. But when the flow of that extra ‘fuel’ dries up in the unfavorable season it is often difficult for the market to rally even if the surrounding news is positive.
QUESTIONS.
After we introduced our Seasonal Timing Strategy to the general public in Riding the Bear in 1999, we received hundreds of letters with good questions.
What were the worst down-years you encountered in back-testing the strategy?
There have been only six years since 1970 in which the strategy was down for the year. The worst of those declines was last year's 3.6% decline (in 2008). Prior to that the worst decline for a year was 2.5% in 1977.
What about the tax consequences of seasonal timing?
Being in the market only four to seven months each year would have a tax penalty for some investors. Whether that penalty would be serious enough to offset the benefit of tripling, quadrupling, and more the performance of the Dow, S&P 500, and NASDAQ over the long term, is certainly doubtful, but in any event would be difficult to determine in a manner satisfactory to everyone.
Tax rates vary dramatically depending on an investor's tax bracket. Additionally, some states impose additional state taxes on capital gains, while others do not.
Further, Congress changes the tax holding periods and capital gains rates so frequently as to make it difficult to back test an after-tax performance, and impossible to predict what it would be in the future.
However, we can know seasonal timing would have no tax impact on assets in IRAs, 401Ks, Keough plans, and other tax-deferred portfolios. Nor would it have any impact on those already following a strategy of mutual fund switching, or of making portfolio changes to follow changes in market leadership.
It also would not affect those who think of themselves as buy and hold investors, but on looking back at their portfolio activity realize that is not the reality, that they have engaged in a fair amount of switching in and out of holdings anyway for one reason or another.
We also believe seasonal timing would have a positive impact, even considering taxes, for the majority of those who have been led to believe that since ‘the market always comes back’, they should simply buy and hold. It is our contention that they will bail out when losses pile up in the next bear market (if not before when bad news hits the particular stock or mutual fund they have invested in). But they will bail out in disgust near the lows, rather than near the highs that are usually in place by the end of favorable seasonal periods. At least, that is what has happened to the majority of those who became determined buy and hold investors in previous bull markets.
A few additional observations about taxes that are not specifically related to seasonal timing;
Using money borrowed from the government, which is what deferring taxes by not selling holdings really is, is similar to buying on margin. It leverages one's portfolio. That is wonderful on the way up, as gains are not only being made on the investor's own money, but on the money that would be owed to the government if holdings were sold. But, the portfolio is also leveraged in a down market, and so declines hit investors not only on their own money, but on that portion which is deferred taxes.
Investors also need to realize that if they're sitting on long-term capital gains on which they would pay 15% to 22% in capital gains taxes (federal and state) if they sold the holdings, they are not cushioned against a market correction of 15% to 22% by not selling. What they are saving is paying the 15% to 22% tax only on that portion of their portfolio which is profit. Even then they're not saving it, but just deferring the payment, (and hoping capital gains rates don't go back up). But, in a market correction, the decline takes place on the entire portfolio; the investor's original investment, those paper profits, and the portion that is the government's deferred taxes.
Is your Seasonal Timing Strategy valid only for the DJIA and S&P 500 indexes?
The Seasonal Timing Strategy was back-tested only against the DJIA and S&P 500 because the Dow data goes back to the late 1800s, while the S&P 500 goes back more than 50 years. So both provide enough data to be statistically meaningful and predictive.
And STS is used as one of our Street Smart Report newsletter portfolios in real-time utilizing only index mutual funds (or exchange-traded-funds (ETFs)), on the DJIA and S&P 500 for the same reason. We are not comfortable using some other index, for example the NASDAQ, or a sector index, to follow the signals since they were not specifically included in the research, and have not been around long enough to necessarily provide sufficient historical data to be statistically meaningful.
While other holdings might do as well or better, it is only by using a Dow or S&P 500 Index fund that we can say that if history is any guide, our Seasonal Timing System should continue to greatly outperform the Dow, S&P 500, and Nasdaq over the long term, while using only an index fund on either the Dow or S&P 500.
However, since when the market goes up to any degree it carries most stocks and sectors up with it, it’s reasonable to expect other indexes and sectors would have similar seasonal patterns.
Would the STS strategy be useful using managed mutual funds?
Probably. Again, since the stock market makes most of its gains in its favorable seasons, most stocks and mutual funds should also make most of their gains in the market's favorable seasons. However, individual managed mutual funds were not included in the research for very simple reasons. More than 75% of mutual funds were not in existence even 20 years ago. So there is no way to statistically correlate their past performance with how they might perform in the future. In addition, even if they have longer track records, a change in manager frequently changes the performance.
Have you considered (fill in the blank) as a possible improvement to STS?
The answer in general is that in the course of our research we tried many, many variations in our work to optimize the strategy, and what we have is by far the best we could find. For instance, there are technical indicators other than MACD that have been a bit better in specific periods, but were not as consistent over the long haul.
What about brokerage firms and mutual fund managers that say there is no useful seasonal pattern?
Brokerage firms and mutual fund companies would have a tough time surviving if very many investors were aware of the market's seasonality and moved their money to cash for four to seven months every year. So they must go to whatever lengths they can to distort the information.
Their problem is that numbers don’t lie, they are what they are. So, invariably in trying to refute the very clear proof of the market's consistent seasonal patterns as best they can, these firms run their data from 1900, and even 1850, even though all of the research on seasonality shows the seasonal pattern did not begin to show up until 1950.
As noted before, the seasonal pattern is the result of the extra chunks of money that flow into investors' hands beginning in the fall, from distributions from mutual funds, from Christmas and year-end bonuses, from profit-sharing bonuses, from year-end contributions to 401 K, IRA, and Keough plans, from income tax refunds, and so forth.
However, there were no such extra chunks of money to create favorable seasons prior to 1950, because there were no mutual funds, no 401K plans, IRAs, Keough plans, very few money managers collecting monthly fees, no hedge-fund managers collecting 20% performance fees at the end of each year. The concept of companies sharing their profits with employees through profit-sharing plans had not yet appeared. Income taxes were non-existent (and when they were introduced were a tiny fraction of what they are today), so income tax refunds were not a factor. And so on.
No one who has engaged in research on the market’s seasonality has ever claimed there was a significant seasonal pattern prior to 1950. So when a brokerage firm tries to refute the market's seasonality by running their numbers from 1900 or 1850, and then claim that the advantage of the seasonal periods is too small to utilize, they have totally distorted the results they know they would have if they ran the numbers from 1950 when the market’s clear seasonal patterns began.
Further, they invariably do not include the interest on cash that a seasonal investor would receive in the unfavorable seasons. That may not seem like much in these times when interest rates are very low. However, over the long-term, interest rates repeatedly cycle between being low and being high, with many periods when they have been in double-digits, when an investor would have added an additional 5% to 6% per year to their profits just in the six months they were out of the market. Leaving interest income out of back-testing historical data is a gross distortion of statistical analysis.
Additionally, none of the firms whose seasonal research developed into the ‘Sell in May and Go Away’ observation ever claimed that an investor would outperform the market by investing only in the market's favorable season of Nov. 1 to May 1. The research showed only that an investor so investing would have matched the performance of the S&P 500 over the last 50 years, while taking only 50% of market risk (since they would only be in the market six months out of every twelve).
The brokerage firms acknowledge that when they say that “the advantage of the seasonal periods is too small to utilize, that one might as well remain invested on a buy and hold basis”. (In doing so they ignore the fact that risk management is a very important part of portfolio management).
However, most importantly, Wall Street’s attempts to refute the market's seasonality only refer to the calendar-based ‘Sell in May and Go Away’ maxim. They do not tackle our Seasonal Timing Strategy, which employs MACD to produce seasonal periods that vary from four to seven months in duration.
It is only the combination of the momentum reversal indicator MACD with our more closely defined basic calendar dates that produces the back-tested and real-time performance, in which our Seasonal Timing Strategy approximately triples the performance of the S&P 500.
Does the fact that STS did not beat the market in 2003 and 2006 mean seasonal timing no longer works? Absolutely not! See the first paragraph at the top of this article. Just as there are with all strategies, historically there have been some individual years in which STS did not beat the market. Those years did not prevent the remarkable 50-year record, any more than the underperformance in 2003 and 2006 prevented the record of the last 9 years.
And there is still more that can be done. So we continue that portion of our research that is dedicated to the market's seasonal patterns, working on searching out the different patterns of the Nasdaq, various industry sectors, international markets, mutual funds, ETFs, etc.
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NOTE: This report express our opinions and suggestions, provided only as a supplement to your own further research and decisions. We take care to assure accuracy of contents but accuracy is not guaranteed. Past performance does not imply future results.Copyright © 2009 Asset Management Research Corp. -- ALL RIGHTS RESERVED.
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