Feature: Stock Strategies

Using Seasonal and Cyclical Stock

Market Patterns
By Jeffrey A. Hirsch

Article Highlights
• The presidential election cycle, the best six months and January’s basket of indicators are the three main calendar patterns.
• Stocks perform best during the final two years of a presidential term, with the highest returns occurring in the fourth year.
• An alternative approach to selling in May is to take a more defensive posture.

“Those who cannot remem- impact on the economy and the stock
market. Wars, recessions and bear markets
ber the past are condemned to tend to start or occur in the first half of
repeat it,” proclaimed philosopher the term, with prosperous times and bull
markets in the latter half. This pattern is
George Santayana. I believe that most compelling.
“those who study market history As you can see in Figure 1, the third
are bound to profit from it.” year in the presidential term has the best
There are three main seasonal and performance, as there have been no Dow
cyclical patterns that have stood the test Jones industrial average losses in pre-
of time and consistently provide me election years since war-torn 1939. While
with an edge in managing my portfolios: pre-election years have generally had
the four-year Presidential Election/Stock Market Cycle, the greater gains, election-year market performance has weak-
Best Six Months Switching Strategy and January’s basket of ened, thanks in part recently to the year 2000’s bear market
indicators and trading strategies. and undecided election and the year 2008’s financial crisis.
But first, let’s get one thing straight. While I am a strong
proponent of historical and seasonal market patterns, I am How the Government Manipulates the Economy
always mindful that history never repeats itself exactly. I have to Stay in Power
used history as a guide for navigating current market condi- In an effort to gain reelection, presidents tend to take
tions and anticipating trends with quite a degree of success care of most of their more painful initiatives in the first half
over the years. What we try to get Stock Trader’s Almanac of their term and “prime the pump” in the second half so
traders and investors to do is not necessarily follow historical the electorate is most prosperous when they enter the vot-
patterns to a “T,” but to keep them in mind so they know ing booths. The “making of presidents” is accompanied
when their radar should perk up. by an unsubtle manipulation of the economy. Incumbent
administrations are duty-bound by their parties to retain the
Politics, Politics, Politics reins of power. Incumbent administrations during election
years try to make the economy look good to impress the
What happens on Wall Street is inextricably linked to what electorate and tend to put off unpopular decisions until the
transpires in Washington. For five decades, the Stock Trader’s votes are counted.
Almanac has discussed and demonstrated this phenomenon. After the midterm congressional election and the invari-
The Four-Year Presidential Election/Stock Market Cycle is able seat loss by his party, the president during the next two
the “Old Faithful” of indicators for us. years jiggles fiscal policies to get federal spending, disposable
Presidential elections every four years have a profound income and Social Security benefits up and interest rates and

June 2013 7
 Figure 1. DJIA Average Annual Percentage Gain (1833–2012) midterm year. (A good number of these
midterm bottoms occurred during the
worst six months.)

A 50% Dow Gain From Midterm

Low to Pre-Election High
In the last 13 midterm election years
(second year in the presidential term),
bear markets began or were in progress
nine times; we experienced bull years in
1986, 2006 and 2010 (1994 was flat).
But by the third year (the pre-election
year), the administrations’ focus shift to
“priming the pump.” Policies are enacted
to improve the economic well-being of
the country and its electorate.
From the midterm low to the pre-
election year high, the Dow has gained
nearly 50% on average since 1914. A
swing of such magnitude is equivalent
to a move from 10,000 to 15,000. The
puniest midterm advance, 14.5% from
the 1946 low, was during the industrial
contraction after World War II. The
next four smallest advances were: 1978
(OPEC–Iran) 21.0%, 1930 (economic
collapse) 23.4%, 1966 (Vietnam) 26.7%
and 2010 (European debt) 32.3%.
Source: Stock Trader’s Almanac.
It’s also important to note the
concentration of midterm lows: six in
inflation down. By Election Day, he will the build-up to confrontation with Iraq. January and four in October, plus four
have danced his way into the wallets and Global financial calamity and the secondary lows in 1962, 1974, 1978
hearts of the electorate and, it is hoped, Great Recession sent the second-worst and 1998. On the flip side, the greatest
will have choreographed four more years bear market for the Dow to its ultimate concentration of pre-election year highs
in the White House for his party. low in post-election 2009. Less severe has been in December, with nine occur-
bear markets occurred or were in prog- ring in the last month of the year and
Post-Presidential Year Syndrome ress in 1913, 1917, 1921, 1941, 1949, six on the last trading day of the year.
Subsequently, the “piper must 1953, 1957, 1977 and 1981. Only in 1925,
be paid,” producing an American 1989, 1993 and 1997 were Americans Best Six Months Strategy
phenomenon that we have coined blessed with peace and prosperity in
the Post-Presidential Year Syndrome. the post-election year. There is no such thing as a perfect
Victorious candidates rarely succeed in trading strategy, but our Best Six Months
fulfilling campaign promises of “peace Bottom-Picker’s Paradise Switching Strategy has an undeniable
and prosperity.” Practically all bear markets be- track record. The Best Six Months
Most bear markets began in such gan and ended in the two years after strategy is basically the flip side of the
years—1929, 1937, 1957, 1969, 1973, presidential elections. Bottoms often old “sell in May and go away” adage.
1977 and 1981. Our major wars also occurred in an air of crisis: the Cuban It comes from an old British saw, “Sell
began in years following elections—the Missile Crisis in 1962, tight money in in May and go away, come back on St.
Civil War (1861), World War I (1917), 1966, Cambodia in 1970, Watergate and Leger Day.” Established in 1776, the St.
World War II (1941) and the Vietnam Nixon’s resignation in 1974 and threat Leger Stakes is the last flat thoroughbred
War (1965). Post-election 2001 com- of international monetary collapse in horserace of the year and the final leg
bined with 2002 for the worst back-to- 1982. But crisis often creates opportu- of the English Triple Crown.
back years since 1973–74. (These were nity in the stock market. In the last 13 While the St. Leger Stakes has little
first and second presidential term years). quadrennial cycles since 1961, nine of to do with stock market seasonality, it
We also had 9/11, the war on terror and the 16 bear markets bottomed in the does coincide with the end of the worst

8 AAII Journal
 Feature: Stock Strategies

months of the year for stocks. Market Figure 2. DJIA Monthly Annual Percentage Gain (1950–2012)
seasonality is a reflection of cultural
behavior. In the old days, farming was
the big driver, making August the best
market month—now August is one of
the worst.
This matches the summer vacation
behavior, where traders and investors
prefer the golf course or beach to the
trading floor or computer screen. Institu-
tions’ efforts to beef up their numbers
help drive the market higher in the fourth
quarter, as does holiday shopping and an
influx of year-end bonus money. Then
there’s the New Year, which tends to
bring a positive new-leaf mentality to
forecasts and predictions as well as the
anticipation of strong fourth- and first-
quarter earnings. Source: Stock Trader’s Almanac.
After that, trading volume tends to
decline throughout the summer. In Sep-
tember, there’s back-to-school, back-to- October months lost Figure 3. Average Percentage Change in DJIA
work and end-of-third-quarter portfolio 1,654.97 points, up 37 Since 1950
window dressing that has caused stocks times and down 25.
to sell off, making it the worst month of Figure 3 shows the
the year on average. Though we may be average change in the
experiencing some shifts in seasonality, Dow Jones industrial
the record still shows the clear existence average for both the
of seasonal trends in the stock market. best and worst six-
month periods.
Performance of Best Six Months
Investing in the Dow Jones indus- Seasonal Portfolio
trial average (DJIA) between November Management
1 and April 30 each year and then switch- Use of the words
ing into fixed income for the other six “buy” and “sell” has
months has produced reliable returns created some con-
with reduced risk since 1950. Exog- fusion when used
enous factors and cultural shifts must in conjunction with
be considered, however. Farming made our Best Six Months
August the best month from 1900–1951. Switching Strategy.
In fact, before 1950 the better strategy They are often inter-
appeared to be “buy in May,” the polar preted literally, but
opposite of present day. Compare this this is not necessarily
to modern day where August has been the situation. Exactly
the second-worst month of the year what action an indi-
for the Dow and the S&P 500 index vidual investor takes
since 1987. when we issue our of-
Figure 2 illustrates that November, ficial fall buy or spring
December, January, March and April sell recommendation
are the top months since 1950. Add in depends upon that Source: Stock Trader’s Almanac.
February, and you have an impressive individual’s goals and,
trading strategy. These six consecutive most importantly, risk tolerance. tails simply switching capital between
months gained 14,654.27 Dow points A more conservative way to execute stocks and cash or bonds. During the
in 62 years, up in 48 years and down in our switching strategy, the in-or-out “best months,” an investor or trader is
14, while the remaining May through approach as we like to refer to it, en- fully invested in stocks or stock index

June 2013 9
exchange-traded funds (ETFs) and mu- driving their stock prices down. These an extremely short-term strategy re-
tual funds. During the “worst months,” bargain stocks are often bought back served for the nimblest traders. It has
capital would be taken out of stocks and in January with the help of year-end performed better after market correc-
could be left in cash or used to purchase bonus payments. tions and when there are more new
a bond ETF or bond mutual fund. In a typical year, small-cap stocks lows to choose from. The object is to
Another approach involves making stay on the sidelines, while large-cap buy bargain stocks near their 52-week
adjustments to a portfolio in a more stocks are on the field. Then, around lows and sell any quick, generous gains,
calculated manner. During the “best late October, small stocks begin to wake as these issues can often give up these
months,” additional risk can be taken up and in mid-December they take off. bounce-back gains immediately.
as market gains are expected, but dur- Anticipated year-end dividends, payouts
ing the “worst months,” risk needs to and bonuses could be a factor. Other January Barometer
be reduced, but not necessarily entirely major moves are quite evident just before January’s predictive prowess has
eliminated. There have been several Labor Day—possibly because individual been a powerful tool for traders and
strong “worst months” periods over investors are back from vacations—and investors for decades. Back in 1972,
the past decade, such as 2003 and 2009. off the low points in late October and my father, Yale Hirsch, the creator and
Taking this approach is similar to the November. Small caps hold the lead founder of the Stock Trader’s Almanac,
in-or-out approach; however, instead of through the beginning of May. devised the January Barometer. Ever
exiting all stock positions, a defensive since the passage of the 20th “Lame
posture is taken. Weak or underper- Wall Street’s “Free Lunch” Duck” Amendment to the Constitution
forming positions can be closed out, Investors tend to get rid of their in 1933, it has basically been that as the
stop losses can be raised, new buying losers near year-end for tax purposes, S&P 500 goes in January, so goes the
can be limited and a hedging plan can often hammering these stocks down market for the year.
be implemented. Purchasing out-of-the- to bargain levels. Over the years we The January Barometer has reg-
money index puts, adding bond market have shown in the Stock Trader’s Al- istered only seven major errors since
exposure, and/or taking a position manac that New York Stock Exchange 1950, for an 88.9% accuracy ratio. Of
in a bear market fund would mitigate (NYSE) stocks selling at their lows on the seven major errors, Vietnam affected
portfolio losses in the event a mild sum- December 15 will usually outperform 1966 and 1968. 1982 saw the start of a
mer pullback manifests into something the market by February 15 in the fol- major bull market in August. Two Janu-
more severe such as a full-blown bear lowing year. When there are a huge ary rate cuts and 9/11 affected 2001.
market. This is the approach that we number of new lows, stocks down the The market in January 2003 was held
use in the Almanac Investor Stock and most are selected, even though there are down by the anticipation of military
ETF Portfolios. usually good reasons why some stocks action in Iraq. The second-worst bear
have been battered. We call this the Free market since 1900 ended in March of
January Jambalaya Lunch Strategy. 2009, and Federal Reserve intervention
In response to changing market influenced 2010.
The January Effect conditions, we tweaked the strategy the As the opening of the New Year,
The tendency of small-cap stocks to last 13 years, adding selections from the January is host to many important events,
outperform large-cap stocks in January NASDAQ market, the American Stock indicators and recurring market patterns.
is known as the “January effect.” Exchange (Amex) and the OTC (over- U.S. presidents are inaugurated and pres-
It has been reported that the January the-counter) bulletin board, and selling ent State of the Union addresses. New
effect was first identified by economist in mid-January some years. We have Congresses convene. Financial analysts
and investment banker Sidney Wachtel. come to the conclusion that the most release annual forecasts. Residents of
He studied the seasonal movements prudent course of action is to compile earth return to work and school en mass
in the stock market and is believed to our list from the stocks making new after holiday celebrations. On January’s
have coined the term. Wachtel detailed lows on Triple-Witching Friday before second trading day, the results of the
his research in his 1942 paper, “Certain Christmas, capitalizing on the Santa official Santa Claus Rally are known, and
Observations on Seasonal Movements Claus Rally. (The Santa Claus Rally is on the fifth trading day, the First Five
in Stock Prices,” which was published the propensity for the S&P 500 to rally Days early warning system sounds off
in the Journal of Business. The theory during the last five trading days of De- (when the first five trading days of the
and pattern was that U.S. stock prices cember and the first two of January by year are up, the full year has ended up
outperformed in January and that small an average of 1.5% since 1950.) This 85% of the time over the last 40 years).
caps outperformed large caps in Janu- also gives us the weekend to evaluate However, it is the whole-month gain or
ary. The January effect phenomenon the issues in greater depth and weed out loss of the S&P 500 that triggers our
was originally likely caused by year-end any glaringly problematic stocks. January Barometer. Beyond the obvi-
tax-loss selling of small-cap stocks, This Free Lunch Strategy is only ous reasons, a positive January is much

10 AAII Journal
 Feature: Stock Strategies

better than a negative one, since every Table 1. Three Positive Early Indicators for S&P 500 Full-Year
down January in the S&P 500 since Performance
1938, without exception, has preceded
a new or extended bear market, a 10% Highlighted rows are post-election years.
correction, or a flat year. S&P 500 Index Gain (%)
Detractors of the January Barom- Santa Claus First Five January Last 11 Full
eter refuse to accept the fact that the Year Rally Days Barometer February Months Year
indicator exists for only one reason: 1950 1.3 2.0 1.7 1.0 19.7 21.8
the 20th “Lame Duck” Amendment to 1951 3.1 2.3 6.1 0.6 9.7 16.5
the Constitution. Prior to 1934, newly 1952 1.4 0.6 1.6 (3.6) 10.1 11.8
elected senators and representatives did 1954 1.7 0.5 5.1 0.3 38.0 45.0
not take office until December of the 1958 3.5 2.5 4.3 (2.1) 32.4 38.1
following year, 13 months later (except 1959 3.6 0.3 0.4 (0.02) 8.1 8.5
when new presidents were inaugurated). 1961 1.7 1.2 6.3 2.7 15.8 23.1
Since 1934, Congress convenes in the 1963 1.7 2.6 4.9 (2.9) 13.3 18.9
first week of January and includes those 1964 2.3 1.3 2.7 1.0 10.0 13.0
members newly elected the previous 1965 0.6 0.7 3.3 (0.1) 5.6 9.1
November. Inauguration Day was also 1966 0.1 0.8 0.5 (1.8) (13.5) (13.1)
moved up from March 4 to January 20. 1971 1.9 0.04 4.0 0.9 6.5 10.8
In addition, during January, the president 1972 1.3 1.4 1.8 2.5 13.6 15.6
gives the State of the Union message, 1975 7.2 2.2 12.3 6.0 17.2 31.5
presents the annual budget and sets 1976 4.3 4.9 11.8 (1.1) 6.5 19.1
national goals and priorities. 1979 3.3 2.8 4.0 (3.7) 8.0 12.3
These events affect our economy, 1983 1.2 3.2 3.3 1.9 13.5 17.3
Wall Street and much of the world. Add 1987 2.4 6.2 13.2 3.7 (9.9) 2.0
to that January’s increased cash inflows, 1989 0.9 1.2 7.1 (2.9) 18.8 27.3
portfolio adjustments and market strat- 1995 0.2 0.3 2.4 3.6 30.9 34.1
egizing and it becomes apparent how 1996 1.8 0.4 3.3 0.7 16.5 20.3
prophetic January can be. Switch these 1997 0.1 1.0 6.1 0.6 23.4 31.0
events to any other month and chances 1999 1.3 3.7 4.1 (3.2) 14.8 19.5
are the January Barometer would be- 2004 2.4 1.8 1.7 1.2 7.1 9.0
come a memory. 2006 0.4 3.4 2.5 0.05 10.8 13.6
Over the years, there has been much 2011 1.1 1.1 2.3 3.2 (2.2) (0.003)
debate regarding the efficacy of our 2012 1.9 1.8 4.2 4.1 8.7 13.4
January Barometer. Disbelievers in the 2013 2.0 2.2 5.0 — — —
January Barometer point to the fact that Average 0.5 12.3 17.4
we include January’s S&P 500 change in
the full-year results and that this detracts Source: Stock Trader’s Almanac.
from the January Barometer’s predica-
tive power for the rest of the year. In
light of this debate, we calculated the 4.0% decline in 2000 foreshadowed the has a solid record. Just six of the last
January Barometer results with both the bursting of the tech bubble and a 2.5% 15 post-election-year’s First Five Days
full-year results and the returns for the loss in 2008 preceded the second-worst showed gains. Only 1973 was a loser,
following 11 months (February through bear market in history. There have been coinciding with the start of a major bear
December). You can see these results, several instances in which a Santa Claus market caused by Vietnam, Watergate
along with the S&P 500’s return for Rally preceded bad years or markets, so and the Arab Oil Embargo. The other
the Santa Claus Rally and the First Five some caution is in order. This was the five post-election years gained 22.8%
Days in Table 1. case in 2011, although the market did on average (1961, 1965, 1989, 1997
manage to recoup most of its losses to and 2009).
The Indicator Trifecta finish the year flat. It’s incredible just how bullish it has
The last 40 up First Five Days were been when all three indicators are posi-
The lack of a Santa Claus Rally followed by full-year gains 34 times, tive. Since 1950, all three indicators have
has often been a preliminary indica- an 85.0% accuracy ratio and a 13.6% been positive 27 times and full-year gains
tor of tough times to come. This was average gain for all 40 years. In post- followed 25 times. Losses occurred in
the case recently in 2000 and 2008. A presidential election years, this indicator (continued on page 36)

June 2013 11
and the type of accounts held. The proportion of savings Since so many factors can influence how much should
held in a Roth IRA can be a significant factor in making the be withdrawn from retirement savings, the decision as to
determination, since they are not subject to the RMD rules. whether to switch to basing the withdrawal amount on the
The presence of an annuity adds another layer of com- RMD is one that needs to be revisited every year. Due to
plexity. Non-qualified annuities are exempt from the RMD the complexity of RMD rules, there is not an easy way to
rules, but an annuity held within an IRA is not. (Specific determine the optimal withdrawal rate. One rule of thumb
rules apply to annuities, and questions about them should is that the more money that is held in accounts not subject
be directed to a tax professional.) Plus, to the extent an to RMDs (such as Roth IRAs), the later in life a retiree will
annuity provides enough income, less than 4% may need be forced to base their withdrawal amount on RMDs.
to be withdrawn from other retirement accounts to meet The IRS publishes a helpful list of answers to frequently
living expenses. Pensions and Social Security benefits may asked questions about RMDs (www.irs.gov/Retirement-Plans/
also allow a retiree to lower his actual withdrawal rate below Retirement-Plans-FAQs-regarding-Required-Minimum-
4%. Conversely, some retirees may have no choice but to Distributions). On this webpage, you will find links to the
withdraw more than 4% to meet living expenses, even though distribution tables and worksheets for calculating your RMD.
that increases the risk of running out of money late in life. —Charles Rotblut, CFA, Editor, AAII Journal

Feature: Stock Strategies

(continued from page 11)

1966 (Vietnam) and just barely in 2011 the additional blemish on the record. ing the indicator trifecta. The January
(U.S. debt ceiling and European debt). Eleven-month average gains are impres- Barometer, Santa Claus Rally and First
Excluding January’s performance, the sive at 12.3%. Five Days indicators were all positive this
last 11 months of these years were up In 2013, the S&P posted its 17th year—increasing the odds, but not guar-
24 times. The market’s crash in 1987 is best January gain of all time, complet- anteeing, positive returns for 2013. 

Jeffrey A. Hirsch is chief market strategist at the Magnet Æ Fund and editor-in-chief of the Stock Trader’s Almanac. His latest
book is the “The Little Book of Stock Market Cycles” (John Wiley & Sons, 2012). Find out more at www.aaii.com/authors/jeffrey-
hirsch.

Trading Strategies

(continued from page 34)

whether the periods of 2003–2004 and have appeared in the past, the AAII This leads to my second concluding
November 2007–February 2009 were Sentiment Survey does not predict future point: Never rely on a single indicator
mere blemishes on the survey’s record as market direction. Overly optimistic and when forecasting market direction.
a contrarian indicator or a sign that both pessimistic investor attitudes are char- Rather, consider a variety of factors—in-
optimism and pessimism can remain at acteristics of market tops and bottoms, cluding prevailing valuations, economic
high levels for an extended period of but they do not cause stock prices to data, Federal Reserve policy, government
time. I tend to think the latter will be change direction. Rather, it is changes policies and other prevailing macro
the case, given long-term market history. in expectations of future earnings and trends—and allow for a large margin
The failure of sentiment to work economic and valuation trends that of error in your forecast. As the saying
perfectly highlights two important move stock prices. The timing of such attributed to John Maynard Keynes goes,
points. Though correlations between changes has proven to be difficult to the market can stay irrational longer than
sentiment levels and market direction predict with accuracy. you can stay solvent. 

Charles Rotblut, CFA, is a vice president at AAII and editor of the AAII Journal. Find out more about Charles at www.aaii.com/
authors/charles-rotblut and follow him on Twitter at twitter.com/charlesrotblut.

36 AAII Journal