2021 Grand National: Why horses for courses applies to the investment world
With a history dating back more than 180 years, the Grand National is undoubtedly one of the biggest...
What is Patternicity? It’s the finding of meaningful patterns in meaningless noise.
Humans tend to see patterns everywhere. It’s important when making decisions, judgments and acquiring knowledge. In fact, pattern recognition is imperative to learning and incredibly important from an evolutionary perspective. Unfortunately, that same tendency to see patterns in everything can lead to seeing things that don’t exist.
For example, a popular adage in the UK is “Sell in May and go away, come back on St Leger’s Day”. This theory is based on the idea that the period from May through September is a weak one for stock markets. Unfortunately, over the long term, the data just isn’t consistent enough to prove the saying right or wrong.
“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” — Mark Twain, Pudd’nhead Wilson
The January effect, created in 1972, is the theory that stock market performance in January predicts its performance for the rest of the year. Meaning if the stock market rises in January, it is likely to continue to rise by the end of December. According to the Stock Trader’s Almanac, the effect has a 85.5%* accuracy rate as of 2 January 2020.
In January 2020 the S&P 500 was down -0.87%**, but despite the unpredictability of 2020 the S&P 500 finished 12.65%*** ahead. Yale Hirsch, the creator of the January Barometer, suggests that since 1950, every down January in the S&P 500 preceded a new or extended bear market, or in some cases, a flat market. While the January effect was wrong about the 2020 results, could we still be heading into another bear market? Let’s consult our next theory.
Primarily focused on the US (for obvious reasons), this theory is based on the winner of – you guessed it – the Super Bowl. It says that if a team from the American Football Conference (AFC) wins, an equity bear market will follow. If a team from the National Football Conference (NFC) wins, it will be a bull market.
When the indicator was first suggested by Leonard Koppett in 1978, it had never been wrong. Sounds impressive but it only took into account 11 years of data as the Super Bowl was introduced in 1967. Let’s look more recently. Over the past 20 years, it’s been correct 45% of the time and has called the market incorrectly in each of the past five years.
This year the Buccaneers, a team from the NFC, won Super Bowl LV. This indicates a bull market, right? Two theories, two results: bear market and bull market. How are those patterns looking now? We’ll look at two more theories that relate to later in the year.
I love this one because it has a literacy reference. It’s the theory that stock returns in October are lower than in other months, and it stems from the quote in Mark Twain’s Pudd’nhead Wilson I referenced above. Although the quote is meant to be sarcastic – that stocks are always dangerous – there is belief in this phenomenon, and yes, the stock market crash in 2008 occurred in October.
The Santa Claus rally was first recorded by Yale Hirsch in 1972 alongside the January effect. It involves a rise in stock prices during the last 5 trading days in December and the first 2 trading days in the following January. Over the 7 days in question, stock prices have historically risen more than the average 7 day performance period. Last year, the Santa rally was compounded by a vaccine bounce, seeing an early boost to the stock market.
So, what have we learned? There are patterns and signs everywhere and data correlations can be found if you look hard enough. But they are in no way investment strategies. For most investors, maintaining a buy and hold strategy for the long term works best – and even in the short term and in volatile markets.
One year on from COVID and an investor could have been forgiven for selling out of Chinese equities in January, as news of a growing virus started to break. But the Chinese stock market actually fell less than other areas of the world and recovered a lot faster too. Gains of up to 160% over the next 12 months could have been the opportunity cost of trying to time that particular market.
*Source: Stock Trader’s Almanac and the January Effect, 2 January 2020
**Source: FE Analytics, total returns in sterling, 2 January 2020 to 31 January 2020
***Source: FE Analytics, total returns in sterling, 2 January 2020 to 31 December 2020