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What does seasonal analysis say about stock market trends in December and 2020?

By David Becker

Seasonality is a measurement that shows an identifiable trend in historical returns. What do the seasonals say about December 2019 and the first four months of 2020?

Global stock prices are at an all-time high entering December 2019. While sentiment remains upbeat, investors likely remember the decline in share prices last December – the large sell-off came as the Federal Reserve increased interest rates for the last time in this tightening cycle.

Investors who are interested in trading shares can use historical seasonal movements in the stock market to determine their next move. Despite the adverse market conditions seen in December 2018, the seasonal movements of the stock market trend tend to favour investing in the first four months of a calendar year.

In this article, we will explore seasonal stock market trends and what the seasonals say about December and the first four months of 2020.

What is seasonality?

Seasonality is a measurement that shows identifiable characteristics of a time series. For example, before the driving season in the US, when people go out on the road for summer vacation, the price of gasoline usually rises. The information provides regular and predictable changes that occur every calendar year. Therefore you can define a seasonal pattern as any predictable fluctuation that repeats over a calendar year period.

Understanding seasonality

Seasonality refers to specific periods, which could be calendar months or even specific days. The fluctuations are based on business cycles, weather patterns or certain times of the year like the summer or winter. Seasonality also refers to periodic fluctuations in certain behaviours that occur regularly. For example, consumers generally purchase more merchandise during the holiday season.

While a business that understands seasonality can take advantage of their ability to predict consumer behaviour, investors can use it to perform stock market analysis. It is important to consider the effects of seasonality when evaluating stocks because it can have a big impact on an investor's profits.

For example, it’s important to know that hurricane season in the US starts in July and ends in November. This could be the difference between a successful or losing energy trade. There is generally a reason that certain companies outperform during specific seasons, but it’s more important to know there is a seasonal tendency than to know why there is a seasonal movement in the price of a stock or index.

What do the seasonals say about December and the first four months of 2020?

One way to measure seasonality it to look at the returns of an index or stock over a specific period and calculate the returns during that time frame. The calendar returns of the S&P 500 index show that stock prices are generally higher in December with the large-cap index showing its best returns during the past 20 years in April and November.

During the past 20 years, the S&P 500 index has increased 70 per cent of the time in December with an average gain of 0.7 per cent. While January and February are slightly lower on average, stocks generally see a pick up in returns in March and April.

When you’re looking at a seasonal tendency you want to determine if it covers periods of both economic expansion and contraction. During the past 20 years, there was a global recession in 2001-2002 and 2008-2009. You can also narrow the time frame, to see what the seasonals say about a shorter-period when there was only either a contraction or expansion.

For example, during the last 10 years, there has been mainly economic expansion. Stock prices rallied nine of the past 10 years in April, and eight of the past 10 years in both July and November. This shows investors that the saying “sell in May and go away” does not always bear fruit, as there are times during the summer that stock prices rally. The returns for the S&P 500 index are similar during the past 10 years compared to the past 20 years. The index rose 70 per cent of the time for an average gain of 0.4 per cent (instead of 0.7 per cent).

What does this pattern tell us?

The key to reading the seasonal tendency of an asset is to determine your bias. If you are a short-term trader that likes to trade on both the long and short side of the market, you might consider reducing your short trades during April, July, and November. The seasonal pattern also tells you that you are likely to experience more volatility in January, August, and June.

Monitoring seasonal volatility

In addition to monitoring the seasonal patterns of the large indices such as the S&P 500 index, it’s important to monitor volatility. The VIX volatility index is the implied volatility of the “at the money” S&P 500 index strike prices. This index is referred to as the fear and greed index and describes the demand to protect a portfolio that mimics the S&P 500. When the returns on the VIX are large, it means that volatility is rising along with fear. When the returns on the VIX are negative, it means volatility is falling and complacency is setting in.

Over the past 10 years, following the great recession in the United States, the VIX has experienced strong returns in January, June, August, and December. August has experienced the most turmoil, rising 80 per cent of the time with an average return of 17.7 per cent. The months that seasonally have the lowest returns for the VIX are March, April, July, and November. What this tells investors is that the US benchmark will experience volatility in December and January but is likely to see low volatility and a rally in the markets from February to April.

Key take-aways

The current stock market environment is likely to experience moderate volatility based on seasonal analysis and then the S&P 500 index should turn upward in February. The best stocks to buy today are those that are defensive, given historical seasonal volatility. Stock market results are generally strong in April, July, and November. If you want to perform robust stock market research you should use seasonal trends and incorporate those trends with both your fundamental and technical analysis.

FURTHER READING: Market predictions: will 2020 bring riches or a recession?

FURTHER READING: Goldman Sachs stock market outlook: Seven interesting things we learned

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