Summer Doldrums – Rebalancing Strategy
Doldrums refers to a gloomy feeling, lackluster spirits, listlessness, or a period of inactivity. The Doldrums 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.
Summer doldrums also refers to the perception that during the summer, especially late summer, the stock market may be vulnerable since many are on vacation, resulting in higher-than-normal volatility and lower-than-normal liquidity.
Stocks, sectors, indexes, and markets tend to be influenced by recurring or seasonal tendencies. Whether these historical seasonal tendencies will repeat this year is not as important as recognizing that these tendencies can occur.
Popular seasonality trends include the Santa Claus rally, where stocks rallied ahead of the holidays. Another is the January Effect, a period where small-caps outperformed at the beginning of the year. One of the more popular seasonality trends is the often mentioned "sell in May and go away." During the summer months, stocks struggled with lackluster returns.
Many investors take advantage of these seasonality 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 very long term.
The summer doldrums are upon us once again. Plus, the Federal Reserve is considering tapering by the end of the year, inflation fears remain, and the bull market has appreciated dramatically this year. So, market pundits are advising us to sell.
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, proponents. An alternative strategy is to rebalance positions, sectors, and markets during the Summer Doldrums. The logic of rebalancing is simple - reset assets back to their normal, but at the same time continue to be involved in the marketplace during this lackluster and volatile period.
As noted, the stock market tends to repeat with specific seasonal trends. These seasonal trends affect individual stocks and can influence the directions of stock market indexes, at least from a near-to-medium term perspective.
When investors understand how these trends work, they can make informed and better trading and investment decisions. Although seasonality trends can increase the probability of the outcome, it is not guaranteed and should not be used alone. Investors should complement seasonality studies with other technical disciplines (i.e., trend line, moving averages, and other technical indicators) and never trade against the primary and prevailing trends.
So, what are the seasonality studies saying about August and the months ahead?
In the past 20-years, various stock market indexes show distinct seasonality tendencies. August is generally a flat month for most stock market indexes, reinforcing the Summer Doldrums label. The average return for 10 popular markets showed a 0% return for August over the past 20-years.
In US equities, the benchmark large-cap S&P 500 Index (SPX) is up 63% of the time in August, with average gains of 0.2% over the past 20-years. The blue-chip Dow Jones Industrial Average (INDU) has closed higher 58% of the time with average gains of 0.0%. The broad-based listed NYSE Composite Index (NYA) closed 50% of the time higher with average gains of 0.4% for the month.
The predominately growth-related Nasdaq Composite Index (COMPQ) was the relative outperformer during August. Over the past 20-years, COMPQ closed higher 58% of the time with average gains of 0.7%. The mega-cap technology-laden Nasdaq 100 Index (NDX) also recorded gains 58% of the time, with average gains of 1.0% during August.
The Mid-cap 400 Index (MID) recorded a higher close 58% of the time during August, with average losses of -0.1%. The Small-cap 600 Index (SML) also closed higher than it opened 58% of the time, with average gains of 0.0% for the month. Micro-cap markets or the iShares Microcap ETF (IWC) closed higher 63% of the time but averaged losses of -0.2%.
International stocks decisively underperformed other equity markets. The MSCI EAFE Index (MSEAFE) closed higher only 37% of the time, with average losses of -0.9% for August in the past 20-years. MSCI Emerging Markets Index (MSEMF) also fared poorly, closing the month higher only 42% of the time with average losses of -1.1%.
Like the prior month (July), a quick review of the August seasonality trends spanning the past 20-years shows a decisive tilt in favor of the Nasdaq OTC markets (COMPQ +0.7% and NDX +1.0%). International stocks also underperformed their equity counterparts, evidenced by the poor August performances of MSEAFE (-0.9%) and MSEMF (-1.1%). The larger-cap SPX Index (SPX +0.2%), the blue-chip Dow Jones Industrial (INDU +0.0%), and the broad-based NYSE Index (NYA +0.4%) were mostly flat to slightly higher during August. However, Mid-cap (MID -0.1%), Small-cap (SML +0.0%), Micro-cap (IWC -0.2) were mostly flat-to-down for the month.
S&P 500 sectors performance during the August timeframe showed an average gain of 0.35% for the 11 S&P 500 sectors the past 20-years. The outperformers are Technology, Real Estate, and Consumer Discretionary sectors. August performance ranked by the S&P 500 sectors are XLRE (1.5% gains), XLK (1.2%), XLY (1.0%), XLU (0.7%), XLP (0.5%), XLV (0.2%), XLC (0.1%), XLF (0.0%), XLI (0.0%), XLB (-0.3%), and XLE (-1.1%).
In summary, August tends to be a lackluster month for most stock market indexes. The NASDAQ markets perform the best and the international markets the worst. The broader-based SPX and NYA were slightly higher for the month. Small-caps, Mid-caps, and Micro-caps were predominately flat to down.
From the S&P 500 sector perspective, the August performances again favored the cyclical sectors, including Technology and Consumer Discretionary. Like, last month, Real Estate also outperformed many of its peers. The commodities-driven sectors such as Materials and Energy once again lagged their S&P peers.
With many stock indexes trading at or nearing historic all-time highs, will August be another lackluster month? If so, then investors may want to consider rebalancing to both reduce risk and volatility in their portfolios.