Seasonal Switching Strategy Update & Prep: Midterm Worst Months More Pronounced By: Jeffrey A. Hirsch & Christopher Mistal | March 22, 2018 | Email | Print

Market volatility continues to run hotter than last year, but that’s not saying much as 2017 was a rather docile bull market year. Historically speaking, year-to-date market action is not out of the ordinary for midterm election years. While March has usually performed better in midterm years, we did warn to “beware the Ides of March” and that “stock prices have a propensity to decline, sometimes rather precipitously, during the latter days of” March. Additionally, this week after March Triple Witching is rather treacherous with “DJIA down 20 of the last 30 years—and frequently down sharply.”

 

So as we approach the end of the Best Six Months with five and half weeks to go stocks are struggling to hold the February 8 lows, especially Dow and S&P 500. Today’s precipitous decline cut the gains for the Best Six Months from October 31, 2017 down to about 2.5% for the Dow and 2.7% for the S&P 500. NASDAQ is holding up better with 6.5% gain.

 

The January-February 10% correction and the current March selloff naturally have traders and investors concerned. We are always concerned about the market and that’s why we employ our hybrid market analysis discipline that incorporates: seasonality and cycles, fundamentals, technical analysis, monetary and government policy, as well as psychology and sentiment readings. 

 

So despite the recent uptick in market volatility and the decline in stocks our 2018 bullish annual forecast remains on track. Our best case scenario for Dow 29000 is becoming less likely, while our base case scenario seems more likely for gains in the 8-15% range for the full year. That does not preclude us from a midyear, Worst Six Months selloff  that would culminate in a ~15% correction or even a mini bear like the mini bears we had in 2011 and 2015-2016 of 19.4% and 14.2% respectively on the S&P 500.

 

However, this would set us up for a quintessential midterm year bottom picker’s paradise and what we call the sweet spot of the 4-year – the last quarter of the midterm year and the first two quarters of the pre-election. This three-quarter stretch, highlighted in the table below taken from page 102 in the 2018 Almanac, shows average gains during the sweet spot from October this year to June next year at 20.4% for the Dow, 21.1% for the S&P 500 and 32.0% for NASDAQ! The weak spot of the 4-year cycle is Q2-3 in the midterm year or April-September of this year and has produced losses on average. 

 

 

As you can see in the charts below the worst six months are most pronounced in the midterm year. The amplitude of the trend this year in the purple line is much greater but the trend is still similar to typical midterm year patterns. The January break visible in the red midterm year line came a little later and steeper this year and recent action, including a late-March selloff is in line with history, which is setting us up for an April-May high, followed by a more prominent worst six months. 

 

 

 

The two tables below show the average 47.4% gain on the Dow and the 70.2% average gain on the NASDAQ from the midterm low to the pre-election year high. Note the highlighted concentration of six (6) January and four (4) October Midterm lows and nine (9) December Pre-Election Year highs for the Dow and the four (4) October Midterm lows and four (4) December Pre-Election Year highs for NASDAQ.

 

 

 

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 8.3%. Over the same time period, DJIA has lost an average 1.1% 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. 

 

 

Because of the heightened level of risk of a pullback or correction that has been historically observed during the “Worst Six Months” of the year, May through October, and its historically tepid returns, reducing long exposure and developing a defensive strategy is the approach we take in Almanac Investor. We do not merely “sell in May and go away.” Instead we take some profits, trim or outright sell underperforming stock and ETF positions, tighten stop losses and limit new long exposure.

 

For those with a lower risk tolerance or a desire to take a break from trading, the “Worst Months” are a great opportunity to unwind longs and move into the relative safety of cash, Treasury bonds, gold and/or some combination of. Preservation of capital may be more important than growth and with historical averages and frequency of gains reduced; the “Worst Six Months” are a good time to simply step aside if you prefer. August, September and/or October have provided some excellent buying opportunities in recent years and could do the same again this year. 

 

 

 

Currently, the Almanac Investor Stock Portfolio and ETF Portfolio are positioned with a long-only bias for the “Best Months” with no long exposure to bonds, individual stock or sector shorts, or positions in bear market funds. But, beginning April 2, 2018 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 7-10 Year Treasury (IEF), iShares 20+ Year Treasury (TLT), SPDR Gold (GLD), ProShares Short Dow 30 (DOG), ProShares Short S&P 500 (SH) and/or other protective strategies may 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 now, try to keep your emotion at bay and resist making any rash changes to your portfolio. Stick to your long term strategy and get prepared to implement some Worst Six Months Defense so you are ready for the sweet spot of the four-year cycle later this year.