Issue: 373
Sent: 21-01-2010 13:59:02
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The End of Month Equity Price Effect
John Robertson
Talk of a Santa Claus rally at the end of December highlighted how markets continue to show an irrational tendency to seasonality.
Over the last 20 years, research has shown that seasonal effects persist in equity markets. The so-called Santa Claus rally in U.S. markets at the end of December is one example of equity market behaviour that should not happen.
If there is some tendency for prices to rise at the end of December, widening recognition of its occurrence should cause traders to adjust their behaviour. Whether directly or through the use of derivatives, they should buy equities in mid December and sell toward the end of the month to cancel out any propensity for the seasonal pattern.
Despite the apparent market opportunity, such seasonal effects seem to persist suggesting that they are still not meaningful enough for traders to move against. Even so, arbitrageurs continually make money from smaller differences than we see in many of the seasonal patterns.
It is easy to assume that the seasonal effects are more likely to show up among smaller and more speculative stocks.
Since the beginning of 2000, the average daily movement in the resources stock component of the ASX small ordinaries index, for example, has been +0.08%. This segment of the market has risen at an annualized daily rate of 20.7% with a standard deviation of 24.7%.
Over the same 10 years, the average movement in the index during the last trading day of each month has been 0.39% or an annualized rate of 164% with a standard deviation of 23.2%.
One might be easily tempted to say that this is typical of the smaller end of the resources market. It is well known for its illiquidity and, if unscrupulous promoters were boosting prices at the end of the month to dress up their asset valuations, who would be surprised?
If we look at the other end of the Australian market, namely the 20 leaders, we might have reason to apologize to those trading in resources stocks.
Over the same period of time, the ASX 20 leaders index showed an average daily gain of 0.025% or an annualized increase of 6.3% with a standard deviation of 18.2%.
The average movement in the same index during the last trading day of each month was 0.125% or an annual rate of 36.5% with a standard deviation of 18.5%.
The end of month return among the 20 leaders was 5.1 times the average daily return. The end of month return among the small resources stocks was 5.2 times the average daily return. Not much difference there.
An investment in the 20 leaders purchased at the end of March 2000 and held until November 2009 would have returned 49.1%. Putting aside the practicalities, if the same investor had stayed out of the market for all but the last trading day of each month, his holding would have gained 58.0% or 8.9 percentage points more.
This calculation does not take account of the dividends that would have been missed by adopting the last day of the month trading strategy but nor does it take account of the return on cash holdings during the 29-30 days each month during which funds were not invested in equities.
If these outcomes persist, buying on the last day of the month will generally net a lower return than if, for example, the same market order was completed at other times in the month.
The possibility of a radical overhaul in trading strategy aside, there are some more practical implications of this market irrationality. One is to get your buying done before the end of the month; otherwise, you will be likely to pay too much. Perhaps, keep the selling for the last day.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.
