Secrets Of Success: Don't be seduced by curiosities
Saturday 05 November 2005
How to explain the many seasonal quirks and oddities that crop up in the stock market? Why is it that over the past 20 years the stock market has risen four years out of five in the past two weeks of the year, and only one year in five in the 36th week of the year? Or why have the winter months (October to March) produced so much better returns than the summer months (April to September)?
According to calculations by Stephen Eckett, editor of the UK Stock Market Almanac (from which these fascinating statistics come), the difference in the two periods since 1970 has been a genuine phenomenon. If you only invested in the winter months since 1970, for example - that is to say you put your money into shares on 1 November each year and went back into cash the following 30 April - your portfolio would have grown from £1,000 to £29,500 over the 33-year period. That represents a compound rate of return of 10.5 per cent.
The reverse strategy, investing on 1 May and going back into cash on 31 October, would have seen your £1,000 portfolio more than halve in value, to just £456. In fact, there have only been five years out of the past 33 that the summer portfolio has managed to beat the winter one. That is equivalent to an annual rate of return of minus 2.3 per cent.
The scale and persistence of this seasonal difference in performance certainly surprised me, although it is fair to say that the size of the differential has been less marked in recent years than in earlier ones (and the strategy may not work in the current year, as the market was uncharacteristically strong from May to the end of September, before dipping in October).
In fact, I think it is dangerous to read anything too significant into these statistics, compelling as they appear to be. It is not difficult to find some strong and plausible behavioural reasons, related to the incentives of the fund management business, to explain, for example, why the last two weeks of the year tend to be good ones for the market.
This particular effect may also have something to do with another famous market anomaly, the so-called January effect, a discernible trend for the market to rise disproportionately in the month of January, something which so puzzled academics for a while that it still features in many finance textbooks.
Because the stock market is a discounting machine, if everyone now knows about the January effect, it would be no surprise to find smart investors who have all read the textbooks buying the market in mid-December in order to anticipate the January effect - thereby creating the end-of-year bounce one month earlier.
Most statistical curiosities about the stock market are, however, just that - curiosities, without any enduring significance. It is a well-chronicled foible of human nature that we are prone to see patterns - and give them meaning - even in data that has been generated in a purely random way. We make that mistake every day of our lives.
Any investor who relies on statistical rules of thumb to govern their actions is likely to end up regretting the habit. This is not to say, however, that the stock market is actually, as academics once confidently proclaimed, a purely "random walk", in which each day's price movement is statistically independent of the one that went before.
All the most recent academic evidence I have seen knocks holes in this idea. There does appear to be a statistically significant degree of predictability in the movement of share prices from one period to the next (which is not to say that this is easy to identify or exploit for profit). It also appears to be the case that the stock market has a "long memory", in the sense of being driven by real world undercurrents of varying intensity that can persist for many years.
There also seems to be force in a related notion of mean reversion, the idea that any market price series that moves significantly out of synch with its long-term trend (as measured by standard deviation in statistical terms) will in time revert to that mean - and usually overshoot in the opposite direction.
But even mean reversion remains a hypothesis, not a fact, in the sense that it tells you nothing about timing - in other words, when rather than whether trends will revert. To repeat the famous aphorism of John Maynard Keynes, "markets can stay irrational longer than you can stay solvent".
By doing sensible things, however, with mean reversion on your side, you can at least shift the odds in your favour.
Even then, bad things can still happen. It would be comforting to think that returns in the stock market follow what statisticians call a normal distribution, as you could then calculate the probabilities of outcomes with confidence. In practice, there are too many "outliers" - too many extreme days on both the plus and minus side of the equation - to form a normal "bell curve" shape.
That is why you get such extreme events as the October 1987 crash, when the stock market fell by 12.2 per cent in a day, and why fully 40 per cent of the positive returns from the US stock market in the 1980s came from just 10 trading days. The way the market behaves is more volatile and more lumpy than would be the case if returns were normally distributed.
The behaviour of the stock market is still so complex and also so dynamic that it is beyond the capacity even of modern computers to model its behaviour with any real accuracy.
Never lose sight of that fact when next you read of some statistical curiosity that sounds like it holds the key to future profits.
I can strongly recommend the UK Stock Market Almanac as a useful work of reference, but you should be sure that you treat the curious data pages as working hypothesis, not as gospel truth.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
- 2 Saudis risk new Muslim division with proposal to move Mohamed’s tomb
- 3 A teacher speaks out: 'I'm effectively being forced out of a career that I wanted to love'
- 4 Cee Lo Green: It is only rape if the victim is conscious
Rotherham child sex abuse scandal: Labour Home Office to be probed over what Tony Blair's government knew - and when
What do immigrants really think of Britain? Polish immigrant's Reddit post goes viral
Ashya King: Parents of five-year-old boy refused permission to visit him in hospital and denied bail at Spanish court
With Douglas Carswell joining Ukip, my party has taken another giant step forward
When elitism grips the top of British society to this extent, there is only one answer: abolish private schools
Ashya King: 'Cruel NHS has not given us the treatment we need', says father of five-year-old with brain tumour who fled to Spain
iJobs Money & Business
£30000 - £45000 per annum + benefits+bonus+package: Harrington Starr: Front-Of...
£700 per day: Harrington Starr: Quantitative Developer C++, Python, STL, R, PD...
£700 per day: Harrington Starr: Java/Calypso Developer Java, Calypso, J2EE, J...
£500 per day: Harrington Starr: SQL Developer SQL, C#, Stored Procedures, MDX...
Day In a Page
A first-floor flat with two bedrooms, a spacious reception room and communal grounds in a leafy part of London
A three-bedroom flat with a spacious rootop terrace and balcony, accessed from a private gated courtyard
A Grade II-listed pile with six bedrooms, stables and 39 acres of grounds in Standlake
A two-bedroom flat with boutique hotel-style interiors, close to the foodie haunt of West End Lane
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens
A seven-bedroom Grade II-listed property with a separate self-contained apartment
A five-bedroom Victorian house with three reception rooms and galleried landing, £695,000
A six-bedroom farmhouse with five acres of land in a former cloth-making village
A secluded seven-bedroom detached house with large private garden, £490,000
A three-bedroom cottage overlooking Sarratt village green with open fires and solid oak floors
A three-bedroom maisonette flat in a Grade I-listed, Georgian townhouse in a sought-after location
A one-bedroom apartment located within a private gated development, north of Turnham Green
Look forward to a brighter future at two-bedroom Sunny Cottages, ideal for Londoners looking to downsize
A three-bedroom red-brick cottage with outbuildings and pretty gardens, £200,000
This three-bedroom flat within a former textile factory spans the corner of the fourth floor and has a balcony