Market timing is hard, but some investment adages have, surprisingly, stood the test of time. One is the Halloween indicator. It tells investors to exit stocks in May and return to the market in late October. So far in 2022 the first part of the strategy has worked. Leaving the market in May would have avoided an almost 10% decline in stocks in 2022. Here’s what that rule suggests could happen next.
It’s strange that with all the sophistication of the stock market, simple calendar-based trading rules may create value for investors, but research suggests that they do.
Ben Jacobsen, a professor at the University of Tilburg has studied the trend extensively and finds it to have robust support both over time and across countries. On average, stock markets have historically returned materially more during the November-April period than May-October.
Of course, this does not work every year, but across 114 global stock markets from 1693 to 2017 (where data is available) this rule generally improves performance over a buy-and-hold investment strategy.
The challenge is that it only works, on average, over time. This means that in any given year it may fail, but historically it can add around 4% to average investment performance compared to being in stocks on a buy and hold basis.
As a bonus, are also entering a midterm year, which has been positive for the U.S. stock market historically so there are two indicators suggesting U.S. stocks may be set for a reasonable run over the coming months.
There are challenges though. As mentioned it doesn’t work each year. In fact the chances of this working in a given year are surprisingly close to 50/50 but the returns in good years can be sufficiently strong, that the average return is quite impressive even if you can be sure to come out ahead every year.
There’s also an issue that we don’t know why it works. There are many theories from taxation to the weather, but it is hard to know conclusively what’s driving the effect.
Tax is also a consideration, if you’re investing in a taxable account, it can be helpful to realize long-term capital gains that often have a lower tax rate. If you’re trading every six months, as this rule implies, that may not be optimal for tax purposes as you’ll be making a lot of short-term trades. Higher tax could offset some benefits, even if the strategy works.
The data behind the Halloween indicator is quite strong, and suggest we could see a reasonable return in stocks from around now to April 2023. However, applying the strategy in any single year is risky, but history suggests that those who apply it consistently over a period of years come out ahead. That doesn’t mean it will work in future, but few calendar rules have as much support as the Halloween indicator.