6 Mos market strategy

[DesertCat]

Skimmed it. A couple things I noticed...

They use value weighted indexes, not clear how well this works with standard index funds.

The advantage of this in the U.S. market has been much smaller (0.24% annually instead of 1.55% world wide), this might be due to the "vacation effect" they describe.

It doesn't appear they calculate transaction costs. That would reduce the strategies advantage by anywhere between .5% (U.S.) up to 2% per year.

Why I previously described it as "screwy" is that it's a minor advantage that can be easily washed away by taxes, transaction costs, or a future lessening of the effect. Clearly it can't be done in a taxable account. And it's unclear whether it works in most countries at all when you account for transaction costs.

The one clear advantage of this approach isn't higher returns, it's that it's achieving similar returns with significantly lowered volatility. That's not something that interests me, but if I was a financial planner I might consider whether recommending a variation of this approach for my clients tax deferred accounts.

[Jeff W]

[ QUOTE ]
They use value weighted indexes, not clear how well this works with standard index funds.

[/ QUOTE ]

I noticed that too... maybe someone knows how those indices compare.

[ QUOTE ]
The advantage of this in the U.S. market has been much smaller (0.24% annually instead of 1.55% world wide), this might be due to the "vacation effect" they describe.

[/ QUOTE ]

True. For those who don't want to read the paper: World Index Mean return was 10.92% with 16.76% StD for Buy-and-Hold vs. 12.47% return and 12.58% StD for Halloween Strategy from 1973-1996. (Table A in paper). For U.S. it was 11.37% retur, 16.40 StD for Buy/Hold and 11.37 return/11.61 StD for Halloween Strategy.

[Jeff W]

Oops, the figures for US Halloween Strategyare 11.61/11.38, not 11.37/11.61

[CrushinFelt]

Are they stated as being statistically different? Surely they ran that simple test...

[kimchi]

I did back-testing of my own some years ago using the 'sell in may' strategy. Since I was in The UK at the time I tested The FTSE, DAX & CAC. I could only get data going back to the early '80s for the FTSE, and a little later for the others so there weren't a huge amount of trades I could test.

I'll try and find the old file or post a few graphs if anyone is interested. All indexes were significantly out-performed by this simple "Sell in May" strategy, although the results were skewed by the 2000-02 bear where the big losses occured in the late spring-autumn periods.

Risk was substantially reduced and the return was greatly enhanced by switching to money markets or corporate bonds & gilts for the particular country's index during the summer months.

I also tested using spreadbetting and CFDs which allowed for highly-margined trading. This was at a time of very low interest rates and so the financing rates were lower than they are today.

I imagine it would work better with index futures where the cost of financing and trading would be lower.

[Tater10]

How about this for a 'solution' to taxes and dividends:

Since the futures trade at a premium of the Risk free rate - dividend rate, you could short the Dow futures in april. You would, in effect, be long the RF rate from april - october. No need to sell your stocks (and pay LT taxes & commission.) You still receive your stock dividend payments.

Total commissions & 'slippage' for a $60k portfolio of dow stocks would be ~$20 per year. Of course, you'd have to convince your broker to use your stocks as collateral, which is possible.

Disadvantages to this strategy:

* If the market does tank, you have to pay taxes on your "gains".
* If the market rallies, you have a loss, and may not be able to use all of it on your taxes next year.

[spider]

Just some general comments... I'm not real current on the latest research but I know there has been considerable study of this kind of thing via the "September effect" or seasonality. So, you guys may want to search on that. IIRC, the basic findings are that there is a statistically significant seasonal effect (in particular, stocks declining in September). There are lots of explanations ranging from the tax deadlines to SAD (seasonal affective disorder). So far, I've never heard a really convincing explanation, which makes me pretty sceptical that there is a exploitable strategy going forward.

[kimchi]

Here's a link to a chart showing the Dow's average monthly returns since 1950:

[Tater10]

[ QUOTE ]
So far, I've never heard a really convincing explanation, which makes me pretty sceptical that there is a exploitable strategy going forward.

[/ QUOTE ]

Would you say buy and hold is an exploitable strategy - will it make money over the next 50 years?

note: I don't think the 6 month strategy is a Holy Grail. But I do think that with 50 years behind it, there should be a reason.

[kimchi]

I dug out my old backtest using the “Sell in May” strategy. Some people mentioned that the effects of this method will be offset by transaction costs, taxes, and lost dividends. I invest most of my money into ISAs, which are available to UK investors. They’re tax free, and there’s no transaction charges to switch funds between many unit trusts, including funds that track indexes.

Starting this month, UK investors can also switch funds from a stocks & shares ISA into a cash ISA paying up to 6.5% interest tax-free – so these are suitable to park funds between the months of May and October, as per the strategy outlines by the OP.

I can’t be bothered to post all the graphs, but these results are in the following format:

Country’s main index (1000 invested in the index since year)
Buy & Hold
Risk-free return (assumed around 3%/year in a MMA)
strategy return (0% interest during summer period)
inverse of strategy return (0% interest during winter period)
strategy return + MMA interest during summer period

Japan (1984)
1487
2007
3302
450
4661

Sydney (1984)
8529
1972
5420
1574
7592

Hong Kong (1986)
6457
1839
4825
1338
6510

Singapore (1987)
3403
1785
6871
495
9133

UK (1984)
5617
1992
5927
948
8365

France (1990)
2868
1668
5601
512
7226

Germany (1990)
4522
1635
5987
755
7609

Swiss (1990)
5788
1635
4495
1288
5713

S&P500 (1950)
62012
5559
35791
1733
84069

Nasdaq (1971)
20184
2955
16309
1238
27967

DJI (1928)
40042
10507
33742
1187
108828

As you can see, the strategy outperforms the inverse of the strategy in all cases. Putting the money into an interest-bearing account during the summer period outperforms buy & hold in all cases (except Swiss & Sydney). On a risk-adjusted basis, this out-performance is very significant.

The most data was from The DJIA which returned more than 2.5x buy & hold with half the risk.

The performance of the inverse of the strategy was appalling. In fact, you would have been better off in many cases leaving your money under your pillow than risking it in the stock market during the summer periods.

I didn’t take into account dividends, taxes, currency risk, fund TER, or transaction charges for this test. As I said earlier however, UK investors have a vehicle that can dodge most of these costs, and I don't have dividend data to hand.