The dictionary defines doldrums as gloomy feelings, lackluster spirits, listlessness, or a period of inactivity. It is also a popular nautical term to describe the belt around the Earth, situated near the equator, where sailing ships suffer from a lack of wind.
In the financial world, summer doldrums refers to the perception that in the summer and especially late summer, many investors are on vacation, resulting in lower market liquidity and higher volatility.
Although seasonal tendencies are influential, recognizing that they can repeat is far less important than understanding that these tendencies can occur.
Popular seasonality trends include the Santa Claus rally, in which stocks rallied into the holidays. Another is the January Effect when small-caps tend to outperform at the beginning of the year. The popular and often-mentioned "Sell in May and go away" suggests during the summer months, stocks underperform when investors are on vacation and rally soon after the summer.
Many investors take advantage of these seasonal trends to buy and sell. In prevailing uptrends, they use seasonal low points to buy and average into long positions. In primary downtrends, they utilize seasonal high points to sell their losers.
Many more investors believe the markets are inherently unpredictable. Anticipating the summer doldrums is useless since you can find just about any period that has been profitable or unprofitable. They believe the buy-and-hold strategy can produce the best annual rate of return over the long term.
The summer doldrums may be upon us again as market pundits advise caution in stocks during August. However, there may be a more effective strategy during the summer doldrum periods without adhering strictly to the buy-and-hold or the sell-in-May and Go Away concept. An alternative investment approach is rebalancing portfolios during late Summer to early Fall. The logic is simple. Rebalancing positions allow an investor to remain active in the marketplace and, at the same time, improve upon the quality of the portfolio during this dull and lackluster period.
As noted, the stock market tends to follow specific seasonal trends. Seasonal trends can impact the performances of markets, indexes, sectors, and individual stocks, at least from a near-to-medium-term perspective.
Understanding the seasonal trends allow the investor to make confident and informed trading and investment decisions. Although seasonal trends can increase the probability of the outcome, it is not guaranteed. It must not be deployed alone but with other technical disciplines (i.e., trend lines, moving averages, and other technical indicators). Investors also should not trade against the primary and prevailing trends.
So, what are the seasonality studies saying about August?
In the past 20 years, stock market indexes recorded mixed seasonality tendencies. August is generally a flat-to-down month for most stock market indexes, reinforcing the Summer Doldrums seasonality label.
The benchmark large-cap S&P 500 Index (SPX) is up 58% of the time in August, with average gains of 0.0% over the past 20 years. The blue-chip Dow Jones Industrial Average (INDU) closed higher 60% of the time with average losses of -0.2%. The broad-based listed NYSE Composite Index (NYA) closed 50% of the time higher, with average losses of -0.5% for the month.
The predominately growth-related Nasdaq Composite Index (COMPQ) was a relative outperformer during August. Over the past 20 years, COMPQ closed higher 55% of the time with average gains of 0.4%. The mega-cap technology-laden Nasdaq 100 Index (NDX) also recorded gains 55% of the time, with average gains of 0.7% during August.
The Mid-cap 400 Index (MID) recorded a higher close 50% of the time during August, with average losses of -0.4%. The Small-cap 600 Index (SML) also closed higher than it opened 50% of the time, with average losses of -0.4% for the month. Micro-cap markets or the iShares Microcap ETF (IWC) closed higher 63% of the time but averaged gains of 0.0%.
International stocks decisively underperformed other equity markets. The MSCI EAFE Index (MSEAFE) closed higher only 37% of the time, with average losses of -1.1% for August in the past 20 years. MSCI Emerging Markets Index (MSEMF) also fared poorly, closing the month higher only 47% of the time with average losses of -1.3%.
In summary, August tends to be a lackluster month for most major stock market indexes. August seasonality favors two specific market indexes. The Nasdaq Composite Index and Nasdaq 100 Index recorded superior gains during August, averaging 0.4.%/0.7%. The other U.S. markets were less fortunate, trading flat-to-down for the month, ranging from 0% (SPX and IWC) to -0.5% (NYA). International stocks fared the worst, with MSEAFE declining -1.1% and MSEMF falling -1.3%.
Surprisingly, most S&P 500 sectors performed well during August, with XLRE (1.1% gains), XLK (0.8%), XLU (0.5%), XLY (0.3%), XLP (0.3%), XLV (0.1%), XLC (0.1%), XLF (0.1%), XLI (-0.2%), XLB (-0.5%), and XLE (-1.5%). The August performances favored the cyclical sectors, including Technology and Consumer Discretionary. Also, Real Estate dramatically outperformed many of its peers. Commodities-driven sectors, including Materials and Energy, severely lagged behind their S&P peers.
Will August be another lackluster month?
Will investors use the consolidation period during August and possibly early September as an opportunity to upgrade their stock portfolios ahead of another year-end stock market rally?