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Wall Street's popular 'rules of thumb' failed investors in 2014

Michael Santoli
Michael Santoli

There are plenty of handy guidelines for playing the stock market based on historical patterns and observed seasonal rhythms.

In 2014, it would have been best to ignore them. Close adherence to the calendar-based wisdom would have caused investors to miss much of the year’s upside and likely would have put them in the wrong kind of stocks for the rally that followed the October low.

Market commentators, and we in the financial media, make heavy use of such almanac-style “rules” such as: “As goes January, so goes the year,” and “Sell in May and go away.” Not so long ago, these maxims were little more than the obscure mumblings of Wall Street’s archivists and fodder for Yale Hirsch’s pioneering Stock Trader’s Almanac (carried on by his son, Yahoo Finance Contributor Jeffrey Hirsch).

Yet the prevalence of investment-oriented media with a need to apply some framework or storyline on the inscrutable markets, driven by the wisdom and madness of crowds, has made them mainstream. The ease with which historical market data can be shaped to back-test trends has also boosted their popularity.

So here’s a rundown of several widely circulated seasonal “trades” that didn’t work out this year.

The January Indicator

January is packed with supposed clues and patterns worth tracking. The January Indicator says that when stock indexes are down for the first month of the year, the rest of the year tends to be unusually weak.

In years since 1945 when January was up, the rest of the year was up 84% of the time for an average gain of 11.2%. When January was a loser, the rest of the year was up slightly more than half the time, with an average return of only 0.2%.

In 2014, stocks dropped right from the start, with the Standard & Poor’s 500 shedding 3.6% in January. The January Indicator would have suggested the remainder of the year would be a relatively tough stretch. In fact, to date the S&P 500 is up 12.6% since Jan. 31 -- better than even the average year when January rose.

[Though widely misapplied, the term “January Effect” refers to the pattern in which small-cap stocks often outperform large ones in January, perhaps because many smaller names rebound from December tax-loss selling. This effect held, barely, with the small-cap Russell 2000 losing 2.8% vs. the large-cap S&P 500’s 3.6%.]

Sell in May and Go Away

This couplet is drawn from the fact that the vast majority of equity-market returns across more than a century were accrued between Nov. 1 and April 30.

Does anyone dutifully go to cash on April 30 and stay on the sidelines until Halloween? Doubtful, but there is always cacophonous chatter about this “rule” each spring, which enables folks to hype the “best six months of the year” ahead of November.

Well, this year the S&P rose more than 7% from May through October -- the majority of this year’s upside -- with a maximum loss of 1.1% at the October low.

The Worst Two Months of the Presidential Cycle

Largely overlapping this year with the “sell in May” period, the second and third quarters of a midterm election year have been, over time, the worst of the four-year election/market cycle.

The electoral cycle is a durable one, showing outsized stock-market strength in the third and fourth years of a president’s term. While the sample size is not that vast -- there haven’t been all that many presidential terms -- the midterm year has been toughest.

Oh well. This year, the “worst two quarters” had the market up 7%.

Buy Volatile Growth Stocks for a Late-Year Rally

This is less of a time-cured market cue, but one that has come on strong in recent years as traders try to get ahead of underperforming hedge funds chasing high-flyer stocks to try to eke out a decent year.

The idea here is that when the market has been up heading into the fourth quarter, buying more volatile “high beta” stocks is the way to do this.

Yet in the current quarter, the PowerShares S&P 500 High Beta ETF (SPHB), a proxy for these juiced growth stocks, has badly trailed its opposite number, PowerShares S&P 500 Low Volatility ETF (SPLV).

So what lessons are to be heeded from the spotty record of market maxims in 2014?

One takeaway is that a strong market trend will tend to override short-term seasonal tendencies. In most of the above cases, the market powered higher at times when the standard wisdom suggested it should suffer or stall.

More broadly, seasonal trends should be viewed not as weather, but as climate: They offer a broad picture of how things are likely to go with all else held equal, but they’re no good for telling you how to dress (or trade) on a given day. Keep this in mind as you hear market handicappers base bullish calls on the historical strength of the third year of the election cycle (which starts in a couple of weeks).

There’s also the chance the sheer popularity of these almanac-based patterns have diluted what value they once had.

Many sharp analysts and traders do great work incorporating seasonal inputs into broader tactical studies that also account for market trends, other asset-price moves, fund flows and investor sentiment. But reacting to a catchy saying or the date on the calendar is no way to treat real money.