Each and every year, equities and the markets in general are influenced by seasonal trends. By recognizing and understanding seasonal, as well as cyclical trends, a trader can potentially earn a market advantage. Of course, nothing in the markets based upon past performance is ever guaranteed, but any edge that can be garnered is well worth some due diligence.
If you’re around the market for any period of time, you’re certainly going to start hearing and reading about things like the “January effect” or “Santa Claus rally” and other things similar. This is all about seasonality. For instance, the “January effect,” the first five trading days of a new year, is thought to be a proxy for how the year will go. The thought process is underpinned by the mentality that investors dump losing stocks at the end of the year for tax-loss purposes and then, if there is an optimistic mood, buyers will come in and snap them up at discounted prices in the first days of the year.
“Seasonality” can be far-reaching. It can have to do with political elections, earnings reports, the weather and even just the calendar. Politics can obviously play a role, considering lawmakers effect on business. Political parties are often at odds with each other on subjects, with investors generally buying or selling stocks based upon political platforms and perception of who is winning coming into an election. Earnings seasons always carry weight with investors reacting to the market and individual stocks ahead of “earnings season” or a particular company releasing results as compared to consensus expectations.
The weather can also be impactful. Consider a hurricane blasting coastal states, causing billions of dollars in damage. Sadly, there are positive effects for some companies (home improvement stores) and negative effects for others (insurance companies) that will move on the effect of the storm. The same can go for a snow storm or any other force of nature that can have a meaningful impact. Weather is also in the definition of seasonality (in most places in the world anyway). For simplicity’s sake, think about a company that sells snow shovels. Buying interest in the company may be much higher at colder times of the year when sales are probably higher.
It may seem odd, but even a month all on its own can be a product of seasonality. Trends don’t become trends for no reason, they’re underscored by fact and often can be a bit of a self-fulfilling prophecy as traders all act upon what is expected. For instance, October is historically a volatile month, so quick flips may be a good trading strategy on big moves. September is often bearish for stocks and July a month of lower volume as part of the “summer doldrums,” so if you’re looking for excitement, you may want to consider something else.
The market also has a strong tendency to be cyclical. This can be looked at a couple different ways. For example, some stocks move nearly like clockwork with the economy. Again, if you’ve spent any time around the market, you’ll hear things like “Investors are getting defensive.” or “Growth stocks are moving.” In these cases, stocks are moving in groups based upon a larger factor that can happen at any time. To lend some color, you can almost be certain that when the economy is limping along or interest rates are being raised, traders are moving their money into things like utilities and consumer staples, meaning they’re investing in things that people have to spend money on because financial times are tight so consumers don’t have extra money to fritter away.
Traders jumping into growth stocks often happens during times of market exuberance. Growth stocks have high price-to-earnings ratios, don’t pay dividends and often have a cult-like following because of their potential to be disruptive in the future. They are essentially the opposite of value stocks, which are often more conservative and reliable by market standards.
Individual companies can exemplify cyclicality nearly to the letter. Take biotech. Drug makers tend to gain in value ahead of an FDA decision about whether or not to approve a drug.
Cyclicality can span entire markets. Gold and commodities are great examples here. When oil prices are on the rise, chances are you can throw a dart and hit a company in the oil space that is gaining in market value. Same thing when oil prices are falling. The caveat here is no different than any other investment…perform your due diligence. If an oil and gas company is racked with debt and oil prices are sinking, this may be a good opportunity to be short the stock. The reverse is true for a company with ultra-clean books during a bullish environment.
It can essentially be said that everything in the market is cyclical. This makes sense when you comprehend that nothing can go up forever; there will be undulations in between. Many traders and analysts look at long term charts for “super cycles,” a phenomenon of a market (could be gold, biotech or a market sector) trending for several years in one direction, often to the downside, to find the time for a reversal. Unlike an individual stock (which can actually go down forever and be completely wiped out), market sectors cannot. After several years of a downtrend, especially without any sound fundamental reason other than essentially sentiment, a sector tends to reverse as bargain hunters look for deals.
Like with seasonality, cyclicality can be self-fulfilling. If there is one thing that can be said about the stock market with relative certainty, it is that traders love momentum. If a reason to get a movement going, albeit a seasonal or cyclical one, traders are going to emphasize it. That’s why seasonal and cyclical effects will always be in play throughout the market, so learn to recognize them.
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