Friday, October 16, 2009

Market Alchemy

Is it possible to exploit stock market superstitions for real returns - something like turning a hunk of iron into gold? Maybe it is just the fanciful fall season when ghosts and goblins reign or lack of any other inspiring force in the U.S. equity markets. Nonetheless, the various stock market superstitions are worth consideration for consistent and exploitable patterns.

Consider the so-called October Effect that has arisen out of the many ugly events that have occurred in this month. The list includes October 27, 1997, triggered by a financial crisis in Asia and Black Monday on October 19, 1987, when U.S. and European indices plummeted. Do not forget the beginning of the Great Depression during the 1930’s that was triggered by a major stock market crash in October 1929. We believe the October timing is more a matter of quarterly financial reporting patterns wherein public companies can no longer delay the accounting “true-up” that discloses weaknesses in orders, inventories and cash flows.

The question is whether these unforgettable events mean that investors can “short October” and get consistent returns. Not likely since in most October months the U.S. stock market ends higher than the beginning.

I believe this is likely because of the old maxim to “sell in May and go away.” This was an investing practice that actually began in the U.K. when investors were advised to leave the market during the summer holiday period. The habit continues, leaving a measurable effect that shows the November to April period consistently produces higher returns than the period May to October. Thus rather than shorting the month of October, investors should begin looking for value stocks to exploit the November-to-April effect.

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