On Stocks and Seasonality

I'm often asked about market cycles and how I incorporate something like seasonality into my process.  The short answer is I bucket them under "interesting, but not vital."

Here's the somewhat longer answer...

When I teach technical analysis, I start with price.  Are we in an uptrend or downtrend?  All the indicators, cycles, waves, etc. are meaningless without first establishing the trend.

So when someone says, "The stock market is seasonally weak in September and October," I usually respond with, "If the market's going up, I'd want to own stocks.  If the market is going down, then I'd probably not want to own stocks."  That simple.

I've worked with enough investors and traders that use cycles successfully to believe that there is a cyclical nature to many things in life, including the markets.  I enjoy when people like Tony Plummer speak on Kondratieff seasons as it just makes sense to me.  If you look at history, we tend to have major wars and major market bottoms about once a generation.  

If you ever want to identify the "generational lows," just run a 10-yr rate-of-change on the S&P 500. When the indicator goes below zero, there's your generational low.

When a cycle of interest comes due, I would never take action based only on that information.  A cycle serves as a signal to watch the price and look for some sort of confirmation.  Unless we get a confirmatory move in price, then the cycle is just noise.

For example, take the four-year cycle.  At times, this has been uncannily accurate in identifying intermediate-term market bottoms.  However, there are years where the cycle has come and gone with no meaningful correction.

SPX four-year cycle from 1960-2018

I remember discussing this particular issue with legendary technical analyst Walter Deemer, who stressed that when the cycle has been delayed then the correction has been even more painful.  See 1987 and 2009 in the chart above.

If we consider 2014 to be another missed cycle low, and the 2015 correction as the delayed reaction, then 2018 should be another cycle low.  We may have seen that earlier this year in a correction that certainly felt violent and significant when it happened.

The problem is that we won't know if that was a cycle low for a couple years.  This sort of chart is compelling when you look backward, but less compelling when you look forward.  What should compel you to take action is price itself.

So February 2018 may have been the cycle low that will allow this cycle to persist for years to come.  Or this may be the early innings of a much larger and more drawn out corrective period, taking us to new lows.

What will tell us which of those scenarios is playing out?  Price itself.

One more word of caution on cycles...

I have heard some people say things like, "the market is down because of cyclical weakness."  As far as I'm concerned, a cycle itself does not cause price weakness.  The fundamental and behavioral conditions are what cause price to move.  A cyclical pattern that emerges is an observable result of the supply and demand in the market, not a reason why the price moves in the first place.

Right now, we are in a seasonally weak period in the markets, as popularized by the oft-repeated quote, "Sell in May and go away."

Owning US stocks has been a fairly good decision so far this summer.  As long as we continue to see a pattern of higher highs and higher lows, the trend is up despite any seasonal trends in history.


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