The stock market is not as unpredictable as many investors believe. During the last four decades, investors gained 9.9 per cent in the average year by holding shares from November to April. But they lost money in the typical year by investing in May to October.
Imagine that you invested £1,000 in November 1960 in a cross-section of UK shares. Further assume you liquidated your portfolio six months later, on April 30, 1961. You elected to place all of the cash under a mattress for six months, and reinvested the entire amount the following November. During the last 44 years, this mindless investment strategy would have generated a profit 35 times versus just nine losses. Your portfolio would now be worth more than £64,000.
If you reversed this strategy and invested from May to October throughout the last 44 years, your shares would have risen 22 times and fallen 22 times. Your portfolio would now be worth just £423.
This example is quite unrealistic of course for it ignores dividend reinvestment, trading charges and taxes. Even so, it makes a clear point. Most long-term investors are better off with their funds in a neighborhood building society account when the middle of the year rolls around.
Poor stock market conditions in recent years had little effect on these seasonal differences. November to April continued to out-perform the middle of the year. For example, UK shares lost seven per cent of their value from November 2000 to April 2001. As painful as this loss was, the next six months were even worse with a decline in the average portfolio of 16 per cent. The following 12 months saw more of the same.
One of the occasional exceptions to the rule occurred from November 2002 to October 2003. Shares fell two per cent from November to April and then gained 12 per cent in the next six months, completely opposite what generally happens.
But even in this atypical year, it is worth noting that the stock market had fallen almost 18 per cent from November to March 12. A powerful rally then clawed back almost all of those losses in the final six weeks of the winter period.
This tendency toward end-of-year strength is pervasive. It occurs when the economy is booming as well as limping. Inflation, interest rates, or even the political party in power appears to have little effect on the trend, nor does the strength or weakness of Sterling.
Just why does the stock market rise so often near year-end? Analysts offer many theories. But the simple truth is that no one knows the answer with certainty.
Even so, City professionals have long been aware that profits are easier to come by in winter months. It helps to explain the old adage that investors should "Sell in May and go away. Don't come back until St. Leger's Day" which is in mid-September. The nameless City poet who coined this famous ditty did not get his dates precisely right. But he described a trend that continues to run right to the present.
As far as this year's cycle is concerned, November started off well but shares weakened in recent days. The UK stock market now sits two per cent above its November starting point. If the past is any guide, the current sell-off is likely to be a temporary phenomenon. Further gains lie just ahead.