Seasonal Switching Strategy Update: Worst Six Months Preparation
By: Christopher Mistal
March 24, 2016
From our Seasonal MACD Buy Signal on October 5, 2015 through yesterday’s close, DJIA gained 4.3%, S&P 500 climbed 2.5% while NASDAQ was off 0.3%. Although this performance is well below average for the “Best Six Months” (NASDAQ’s “Best Eight Months” end in June), the market had several major headwinds to overcome. 
First and perhaps most significant, was the first interest rate hike in nearly a decade last December. The fractional increase itself was not all that substantial. However; it did mark the end of zero interest rate policy and a shift in monetary policy from broadly accommodative towards tightening. The anticipation of the shift in policy resulted in a stronger U.S. dollar that pressured commodity prices and our exports. Corporate profits were hit and global growth forecasts declined and the market briskly corrected in January and February. 
Since then, the Fed has taken a much more dovish tone. Further rate hike expectations have fallen from four to just two for the remainder of the year. This shift has softened the U.S. dollar and given commodities a minor boost. The U.S. labor market has also remained resilient, lifting expectations for a quick recovery in growth and corporate profits. The market has managed to climb into positive territory for 2016, but new highs remain distant and unlikely.
The long-term track record of our Seasonal Switching Strategy, which is based upon the “Best Six Months”, has a solid track record of outperformance with potentially less risk compared to a buy and hold approach. Since 1950, DJIA’s average annual gain has been 8.2%. Over the same time period, DJIA has lost an average 1.2% during the “Worst Six Months,” May through October, and gained an average 9.3% during the “Best Six Months,” November through April.
Detractors are quick to point out that there have been positive “bad” months and negative “good” months. This is absolutely true as there is no trading or investment strategy that works 100% of the time (even the best will report a trading loss every once and a while). Even in election years, the second best performing year of the four-year cycle, there have been some nasty selloffs. Most recently in 2008 when DJIA fell 24.7%, S&P 500 dropped 25.8% and NASDAQ declined 29.0% during the worst months during the height of the Financial Crisis.
[DJIA, S&P 500 and NASDAQ Seasonal Switching Strategy during Election Years]
This year, more so than in recent years, Edson Gould’s (Findings & Forecasts, 1902-1987) famous quote, “If the market does not rally, as it should during bullish seasonal periods, it is a sign that other forces are stronger and that when the seasonal period ends those forces will really have their say,” seems appropriate.
Applying Our Seasonal Switching Strategy Recap
Use of the words buy and sell has created some confusion when used in conjunction with our Seasonal Switching Strategy. They are often interpreted literally, but this is not necessarily the situation. Exactly what action an individual investor or trader takes when we issue our official fall buy or spring sell signal depends upon that individual’s goals and, most importantly, risk tolerance. 
A conservative way to execute our switching strategy, the in-or-out approach as we like to refer to it entails simply switching capital between stocks and cash or bonds. During the “Best Months” an investor or trader is fully invested in stocks. Index tracking ETFs and mutual funds are an easy and inexpensive way to gain stock exposure. During the “Worst Months” capital would be taken out of stocks and could be left in cash or used to purchase a bond ETF or bond mutual fund. 
This approach works very well for retirement accounts where the goal is to build wealth over time. It comes with the added advantage of potentially less risk of pure “buy and hold”. Of further benefit, you may find summertime vacations and activities more enjoyable because you will not be concerned with stock market gyrations while your nest egg is parked in the relative safety of cash or bonds.
The approach that we use in the Almanac Investor Stock and ETF Portfolios involves making adjustments to your portfolio in a more calculated, tactical manner. During the “Best Months” additional risk can be taken as market gains are most likely, but during the “Worst Months” risk needs to be reduced, but not necessarily entirely eliminated. There have been several strong “Worst Months” periods such as 2003 and 2009. Taking this approach is similar to the in-or-out approach. However, instead of exiting all long stock positions a defensive posture is taken. 
Weak or underperforming positions can be closed out, stop losses can be tightened, new buying can be limited, and a hedging plan can be implemented. Purchasing out-of-the-money index puts, adding bond market exposure, and/or taking a position in a bear market fund could mitigate portfolio losses in the event a summer pullback manifests into something more severe such as a full blown bear market. 
Worst Months Defense
We are not issuing the signal at this time. We are only prepping for when it arrives.
Currently, the Almanac Investor Stock Portfolio and ETF Portfolio are positioned for the “Best Months” with no exposure to bonds or bear market funds with a long-only bias. But, beginning April 1, 2016 we will begin looking for our seasonal MACD sell signal accompanied by signs of seasonal weakness. Our recent Official Seasonal MACD Sell Signal Alerts proved rather timely as the market topped shortly thereafter.
When both the DJIA and S&P 500 MACD Sell indicators trigger a sell signal, we will issue an Almanac Investor Alert. We will either outright sell specific positions or implement tight trailing stop losses. Bearish/defensive positions in: iShares Barclays 7-10 Year Treasury (IEF), iShares Barclays 20+ Year Treasury (TLT), AdvisorShares Ranger Equity Bear (HDGE) and/or other protective strategies will also be considered. All stock and ETF holdings will be evaluated at that time. ETFs providing exposure to sector seasonalities ending in April and May along with underperforming stocks in the Almanac Investor Stock Portfolio may be sold at that time as well.
For traders and investors employing the “Best 6 + 4-Year Cycle” as detailed on page 62 of the Stock Trader’s Almanac 2016, this year’s upcoming Seasonal MACD Sell signal could be overlooked. Again, individual risk appetite will determine which of the above paths are preferred.