Too Many End-Of-Year Bulls?

John wrote:

I’ve been following the debate on whether the pessimists are correct or not, and so far the market is going our way after your bullish call [one month ago]. I have no idea what will happen next. However, my one comment is that I worry about the “sure thing.” It is “common knowledge” that the market runs up at the end of the year. It “always happens.”

It may well happen again, as it usually does. It’s just that when we count on something to “always” happen, the market has a habit of doing what it likes, and sometimes the sure thing evaporates.

I get worried when everyone agrees.

I do, too, but there’s nothing near a bullish consensus now. In fact, the switch from cautious to bullish here was met with heavy resistance, even insults.

We’re one month into solid returns, but frustrated bears are only nibbling at the idea that the market might rise after all. Read forecasts carefully and you’ll see a lot of reference to downside risks remaining high, the October surprise lurking in the shadows, and such. We’ve decided to charge ahead in full bull regalia despite those fears — which are always present, by the way — and so far we’ve been right.

Even the Fed is hedging, though:

St. Louis Fed President William Poole said Tuesday that the Labor Department’s recent employment report implies the economy is not in as much danger as was feared, but conditions remain delicate. On the same day, San Francisco Fed President Janet Yellen said she is uncertain whether further rate cuts will be required to stabilize the economy. “Financial markets appear to be stabilizing, but they have not returned to normal and are still fragile,” said Poole. He cautioned that housing will likely remain weak for several more quarters. Yellen believes the rate cut helped to contain downside risk, but she said it is too early to tell whether the economy “dodged a bullet.” “I have a totally open mind about what, if anything, is going to be needed from here on in,” she said. [Full Article]

While it’s true that there’s a seasonality to the market, saying everybody is on to it overstates the case. In fact, that “everybody” is generally the Stock Trader’s Almanac, which advocates a mechanical strategy that looks to be getting into the market about now for what it dubs the “best six months.” I criticized the Almanac yesterday for its rough conclusions about the presidential election cycle, and its best six months strategy deserves equal disdain.

Creating skepticism around the strategy doesn’t even take financial analysis. Just think about it. Don’t you suppose that if winning in the market were as easy as putting your money in every fall and taking it out every spring, we’d all just create an automatic timer with our brokerage accounts? Sure we would.

Unfortunately, the strategy isn’t all it’s cracked up to be.

From 1995 to 2005, the Almanac’s prized strategy of combining its “best six months” approach with MACD timing to get better seasonal entries and exits returned a cumulative 225%. Just owning the Nasdaq 100 returned 332%, and that’s including the dot com crash. How much investment acumen does it take to just put your money in a Nasdaq 100 index fund or ETF? Not much, yet it was far better than the Almanac’s seasonal timing strategy.

If you really want to see the lack of research going on at the Almanac, compare its performance to my permanent portfolios. My Maximum Midcap strategy returned 526% just as a lump sum. The extreme volatility of the strategy combined with regular monthly investments did far better, still. In fact, it’s that pairing of extreme volatility with assured recovery that makes the strategy so perfect for the way most people invest: by sending additional funds each month or quarter.

One weakness of the Almanac is that its strategies are based and proven with data going back to 1950. That sounds good in theory because they’re tried and true. Unfortunately, they appear to be a bit old and stodgy. They certainly don’t stand up to the “what have you done for me lately?” rule that most investors employ, whether consciously or not.

For example, the Almanac is proud that its “best six months” with MACD has not had a losing year since 1983. Nice soundbite, but it doesn’t mean much when looking at the bottom line. Volatility is your friend when it eventually moves upward. From 2000 to 2005, the Almanac generated these annual returns: +5%, +16%, +6%, +8%, +2%, +8%. Not a losing year, true, but not much in the way of winnings, either. Maximum Midcap speaks for itself.

So, I wouldn’t worry about the impression that everybody is on board for an end-of-year recovery. First, they’re not. Second, that impression is mostly from the Almanac’s touting of such seasonality, which has not proven to be the most profitable approach to stocks.

This comes up every year, we get through it every year, and I’m sticking with my forecast of a strong medium term — for reasons that have nothing to do with the Almanac’s strategy.

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