Investing for the cycle

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This article was published 18/07/2020 (1936 days ago), so information in it may no longer be current.

Investing is a predictably unpredictable activity.

Yet, like all endeavours taken on by humans, we seek patterns in the chaos. Buying good companies and holding them for the long term may be the credo of the majority of investors. But for a large subset, investing also involves seeking patterns in price movements, poring over stock and index charts over time, hunting for omens of future performance.

Called technical analysis, its adherents — referred to as market technicians — are likely now looking over market data for the next, big downturn.

In fact, some of the biggest names in this field gathered recently — virtually at least — for something called the Financial Cycles Summit. The events featured several seminars on various market cycle topics, many of which are still available for free on YouTube (wfp.to/3AC).

Hosted by the Foundation for the Study of Cycles, the webinar included subjects like “The Mysterious Forces that Trigger Events” and “Navigating the Election Year Bear Market.”

The Free Press spoke recently with the U.S.-based non-profit’s CEO, Richard Smith. Nicknamed the “Doctor of Uncertainty,” he offered his thoughts about markets and finding the potentially profitable patterns in them.

Investing based on market cycles “is so compelling… because the world is so cyclical by nature,” notes the University of California, Berkeley-educated mathematician and PhD in systems science from State University of New York.

Seasons, tides, our biology — they all involve repeating cycles.

“Those of us who are interested in cycles believe there are patterns in our world that aren’t fully recognized or appreciated, and the study of cycles is partly to uncover what those patterns are.”

Of course, investment markets are cyclical too, in his and many other investors’ views, because they are human constructs. And we are very much creatures of habit — or in this case, patterns.

That doesn’t mean you can predict markets with precision based on past market data, but stock markets do exhibit discernable, repeating cycles over long time periods.

“Ultimately, cycles are a tool you can use to invest,” says Smith, based in the Blue Ridge Mountains in Virginia.

But that doesn’t mean investors should use this tool alone to make buy-and-sell decisions. What’s more, market patterns, while consistent over long periods, can vary year to year.

Still some cycles — like the annual, or seasonal trading pattern — are reasonably accurate more often than not for the Dow Jones Industrial Average and S&P 500 indices. Often referred to as the ‘Sell in May and go away’ strategy, this approach is based on the notion stocks typically do well between the start of November and roughly May 1. And they generally perform less well from May to October.

“It’s an astonishing pattern,” Smith says about the seasonal effect on the Dow, also called the “Best Six Months strategy.”

According to stocktradersalmanac.com (based on the bestselling investment book The Stock Trader’s Almanac that popularized seasonal investing), $10,000 invested in the Dow in 1950 would have yielded about $1.4 million by the end of last year. That’s just the buy-and-hold approach, and it’s not too shabby.

But by buying in November and selling in May, and doing that each year over that same span, you would have earned almost $3 million.

In contrast holding stocks only from May to the end of October every year would have resulted in a $5,800 loss. The same rule applies to S&P 500, though selling in May and buying in November was only slightly better than buying and holding the index.

A similar approach works well for the NASDAQ. Albeit, its best-months cycle runs from Nov. 1 to June 30.

The TSX Composite also involves seasonality with typically strong performance over similar time frames. Only it’s called “Buy when it snows! Sell when it goes!” — a term coined by renowned Canadian technical trader Don Vialoux.

Yet it’s not just seasonal patterns that persist in markets. Cycles abound in the noise of asset price data, including shorter spans like between Oct. 27 and Jan. 6 for the Dow.

“Over the last 60 years, if you buy the Dow on Oct. 27 and sell it around Jan. 6, that’s been a profitable trade more than 92 per cent of the time,” Smith says.

This past week capped off another period of traditional strength for the index: June 27 to July 15.

“Over the past 100 years, this has been positive about 78 per cent of the time.”

This year was no exception, he adds.

Some market cycles are much longer, according to some theorists. Among the most notable is the Kondratiev cycle, developed by Soviet economist Nikolai Kondratiev in the 1920s. He posited capitalist economies have 50- to 60-year cycles of booms followed by depressions.

“Most people should be focused on shorter-term cycles than Kondratiev’s waves,” Smith argues.

“They are hard to make practical because not only can they last a lifetime, but also your window of when the cycle might top or bottom can span years, and in the investing world that can seem like an eternity.”

Likely more useful, particularly for this year, is the four-year stock market pattern following the U.S. presidential election cycle.

It often goes something like this: The first year of the presidency is typically slightly positive for markets. The second year is often negative. And the third year is generally strong, with the fourth year being largely flat.

“Why does that four-year cycle happen, and is it really connected to the presidency?” Smith says. “I don’t know, but it is a cycle that has persisted for 100 years.”

Other patterns are downright weird, like one based on the winner of the Super Bowl. When the AFC team wins, like this year’s Kansas City Chiefs, the stock market typically does poorly. And it tends to do well in the years when the NFC wins.

If this seems like mumbo-jumbo, that’s perfectly fine with Smith.

“These cycles persist because people refuse to believe that it can be that simple, and we all have a tendency to think that we’re smarter than everybody else,” he says, adding he does not consider the Super Bowl theory a viable investment strategy.

Of course, Smith isn’t implying investors should bet the farm on market cycles. Rather these patterns are instructive because they can improve the odds of success.

“Investing is a probabilistic endeavour,” he adds.

Even though investors try to make rational decisions, the activity undeniably involves “making bets,” he says.

“You’re trying to understand the probabilities as much as possible … and make sure your reward is going to be more than your risk — but there are no sure things.”