Many things in the world tend to repeat regularly. There are more sunny days in summer than winter, the sale of ice-cream rises during hot days or electricity consumption decreases during days with more extended daylight. These phenomena called seasonalities exist not only in nature or human activities but are also present in the financial markets. They might not be reliable in every cycle, but it is their long-term validity, that should attract our attention. There are specific periods on the market that can bring an investor a greater appreciation of his investments. In the first chart, we take a look at monthly performance and the overall cumulative performance of your strategy. In the table above you can see t-statistics of each month (those with the statistically significant return are marked red).
Turn of the month
There are many anomalies you can take advantage of each month. The turn of the month is a well-known effect on stock indexes, with a simple idea that stock prices usually increase during the last four days and the first three days of each month. Lakonishok and Smidt (1988) were the first to have reported a turn-of-the-month seasonality in equity returns. However, academic research shows, the turn of the month effect isn’t limited just to equity markets. Despite the simplicity of the trading strategy based on this anomaly, the strategy is both profitable and statistically significant.
Moreover, this anomaly cannot be explained by the known asset pricing models. Most researchers ascribe this effect to the timing of monthly cash flows received by pension funds, which are reinvested in the stock market. However, caution is needed if one implements this strategy as calendar effects tend to vanish or rotate to different days in a month.
Turn of the quarter
Similar, but independent anomaly to the turn of the month is the turn of the quarter. The beginning of the turn of the quarter period is defined as the last trading day of the quarter and ending with the third trading day of the following quarter. The fundamental reason for this effect could be because of returns at the turn-of-the-year; however, it is not. The effect occurs at turns of the quarter that coincides with turns of the year, but it also occurs during other quarters. Just like with the turn of the month, most researchers ascribe this effect to the timing of quarterly cash flows. The end of the quarter is also a natural point for portfolio/trading models rebalancing both for retail and professional investors.
The Pre-Holiday Effect is a calendar anomaly in equities – it is the tendency for a stock market to gain on the final trading day before a holiday. Research shows that market return during pre-holiday days is often more than ten times larger than the average return during regular trading days. It seems that a substantial part of the equity premium is concentrated in these several days. This anomaly has been documented in many countries, so its validity seems strong. Pre-holiday days on the market are often characterized by lower liquidity as a lot of market participants are not involved in the market, or they lower their exposure. Therefore, a straightforward strategy could be constructed to exploit this market in-efficiency. The main explanatory factors for this anomaly are behavioral. One explanation states that short-sellers close their risky positions before holidays. Another reason could be investors’ good mood around holidays, indicating greater optimism about prospects and, therefore, a high probability of positive market moves.
One market wisdom says – „Don’t fight the FED“, and academic research agrees with it. Academic studies show that the S&P 500 index average daily returns during Federal Open Market Committee meetings since 1980 are outstanding – more than five times greater than returns during other average days on the market. It means that more than 16% of average yearly returns for the equity index is realized during very few days. Therefore, it handsomely pays to be long during these few days. A simple market timing strategy that exploits this anomaly could be created. As it is only a few days in a year, this strategy could be easily leveraged to obtain higher returns. FOMC meetings are mostly positive for the stock market. The FED’s purpose is to address banking panics, maintain the stability of the financial system, contain systemic risk in financial markets, and strengthen economic growth. Therefore, it is highly unlikely that FOMC meetings’ conclusions would be highly negative for stocks.
Employment Situation Release
Another important date is the day when the Bureau of Labor Statistics (BLS) publishes its monthly employment report. Part of this report is the U3, often referred to as the unemployment rate in the U.S. This is considered the main report on which the unemployment rate is based. Research shows that there’s a strong and direct connection between the unemployment rate and the stock market. As a trader, it’s important to understand the meaning of the unemployment rate and how it can affect your investments. Naturally, when the economy is growing at a healthy pace and jobs are relatively unlimited, it can be expected to fall.
On the other hand, when the economy is in weak shape and jobs are limited, the unemployment rate can be expected to rise. This can cause stock prices to lower in many fields because of the lack of demand for certain goods. A low unemployment rate can be a sign of economic development, while high unemployment can be a sign of an underperforming economy. The size of unemployment rates might also affect the Federal Reserve. Depending on whether the economy is too hot or cold, they can increase or decrease interest rates.
Consumer Price Index (CPI) reflects price changes for a basket of goods and services, that may be changed at specified intervals. While there are multiple ways of measuring inflation, the most popular in the United States is the CPI, reported monthly by the Bureau of Labor Statistics (BLS). There are multiple pros and cons to inflation, but what is important to you as a trader is how inflation impacts an economy. If inflation is falling, traders will bet that the Federal Reserve will be accommodative, helping to lift stock and bond prices. When inflation is rising, traders will often believe that hard assets such as commodities will increase in value as the Fed looks to be less accommodative. Traders will continually evaluate whether the reported CPI was stronger or weaker than expected. Since a surprise, if often not incorporated into the price of an asset, it provides an opportunity to place a trade.
The expiration date for listed stock options in the U.S. is the Friday before third Saturday in each month. On months that the Friday falls on a holiday, the expiration date is on Thursday immediately before. The closer an option gets to its expiration day, the faster it loses value. Options trading can be volatile and unpredictable on the expiration day. However, large-cap stocks with actively traded options tend to have substantially higher average weekly returns during the week before options expiration. Academic research suggests that intra-month weekly patterns in call-related activity contribute to patterns in weekly average equity returns. Hedge rebalancing by option market makers in the largest stocks with the most actively traded options is the main reason for the abnormal stock’s returns.