(This is an excerpt from Friday's blog for Decision Point subscribers.)
We are entering the six-month period of negative seasonality from May 1 through October 30, which will present a headwind to the market's current rising trend. While we do not specifically trade on the basis of these six-month seasonality cycles (positive seasonality exists from November 1 through April 30), we certainly take them into account.
Sy Harding discusses this seasonality in his book Riding the Bear, which he published in 1999. Talk about great timing and going against the crowd! The fact is, there are some concrete reasons why this seasonality exists, and the Investment Industry does its best to denigrate it. The following is quoted from Sy Harding's website https://www.streetsmartreport.com:
"Brokerage firms and mutual fund companies would have a tough time surviving if very many investors were aware of the market's seasonality and moved their money to cash for six months every year. So they must go to whatever lengths they can to distort the information.
"Invariably in trying to refute the very clear proof of the market's consistent seasonal patterns, these firms run their data from 1900, even though all of the research on seasonality shows the seasonal pattern did not begin to show up until 1950. The reason for that is simple. The seasonal pattern results from the extra chunks of money that flow into investors' hands beginning in the fall, from distributions from mutual funds (most of which have fiscal years that end either September 31 or October 31), from Christmas and year-end bonuses, from profit-sharing bonuses, income tax refunds etc. Additionally, extra chunks of money flow automatically into the market at year end from employers' contributions to their employees' 401 K and other pension plans, from automatic re-investment of mutual fund distributions, from tax-payers' annual contributions to their personal IRAs, Keough plans, etc. These extra chunks of money provide $billions of extra fuel for the market over a six month period, driving prices higher in the favorable season. In the spring those extra chunks of money dry up, removing that fuel from the market and making it much more vulnerable to any selling pressures that develop.
"However, there were no such extra chunks of money prior to 1950 because there were no mutual funds, no tax deferred 401K plans, IRAs, Keough plans, etc. The concept of companies sharing their profits with employees through profit-sharing plans had not appeared. Income taxes were non-existent, and when they were introduced were a tiny fraction of what they are today, so income tax refunds were not a factor. And so on."
The last two six-month periods certainly proved the rule. May through October of 2010 embraced a bull market correction and was basically flat. November 2010 through April 29, 2011 was very positive.
In the year between May 2009 and April 2010 the bull market prevailed in both periods.
In the year between May 2008 and April 2009 the bear market prevailed in both periods.
As we enter the next so-called "dead zone" we will be alert to the potential danger, but we will rely on our timing model to give the exit signal, which specifically will occur when the 20-EMA crosses down through the 50-EMA. Currently, both EMAs are rising and diverging, so for now we are on a buy signal and the bull market prevails. Should a negative EMA crossover occur during the next six months, we'll certainly take it seriously.
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Technical analysis is a windsock, not a crystal ball.
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