'Tis the Season(ality)

Attempts to predict the direction of the stock market run the gamut from the sublime to the ridiculous. Besides the usual suspects of fundamental and technical analysis, traders have resorted to astrology, day trading, and other questionable techniques in order to get an edge. This brings us to seasonality, the belief that equities have a tendency to rise and fall during certain times of the year.

Any discussion of calendar-based trading techniques isn’t complete without a nod to the fourth quarter, which historically has been the most profitable three-month period to own stocks. As the two charts show, the returns from October to December are significantly more robust than for the other three quarters. Add to that the tendency for stocks to exhibit less volatility during the period, and the result is the beginning of a timing strategy that even the most daunting believer of stock market efficiency would absolutely drool over.

Or is it?

For starters, historical tendencies are just that–predilections that have proven themselves over time. There is no fundamental reason for stocks to rally in the fourth quarter, and certainly there have been times when the last three months have resulted in losses. Although there is some credence to owning stocks in the fourth quarter, there are also ample reasons for owning them the other nine months of the year.

I also have an issue with the consensus view. If everyone expects there to be a fourth quarter rally–and it’s hard to find an equity strategist from any Wall Street firm who doesn’t–then who will be left to bid up shares if the bulk of traders are busy establishing positions beforehand? We’ve seen some of this occur so far in September, which every calendar fetishist knows is the weakest month of the year.