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Bollinger: Seasonal Signs

09/30/2005 12:00 am EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger does a remarkable job of combining technical and fundamental analysis into a format that is valuable to skilled market players and also easily understood by the novice. Here, he discusses buy-and-hold vs. timing, seasonality, and his current outlook.

"Our view is that there are times for buy and hold and times for market timing. During the big bull-market swings like 1950 to 1966 or 1982 to 1998 buy and hold via an efficient relative-strength allocator like a capitalization-weighted index fund is a close-to-optimal approach. During a consolidation phase, such as that from 1966 to 1982 or that from 1998 through the present, buy and hold returns nothing or worse and the keys to success are market timing and sector and style rotation. It is not that Mr. Bogle's opinion is wrong per se; it is that it is wrong part of the time and we are currently in that part of the time.

"Say what you will, but it seems hard to ignore the potential of market timing in consolidation periods. The S&P 500 has been flat for seven years now and is still at an historically high valuation despite strong earnings growth. We expect that the major averages will be flat for the foreseeable future. In such an environment, active investing is the only investing.

"Those who oppose market timing, usually mutual fund managers and academics beholden to them, use a simple argument: miss a few of the best days and you'll lose out big time. To wit: If you put $1 into the S&P 500 in January of 1950, that dollar turned into $74.46 by September 2005. If you missed the 100 best days in that period, instead of becoming $74 your buck became a measly $2.34. Ouch. Run in fear. Hide. Whatever you do, don't miss those big days or you'll ‘end up in the poor house.’

"However that is not the whole story, just a cleverly-crafted, self-serving distortion. As is the case with all such purposeful claptrap, there is another side(s). For example, consider what would have happened if you missed the worst 100 days instead of the best 100 days. Your $1 would have become $2,908.13. That is not an error. Checked and double-checked; miss the 100 worst days and $1 became over $2,900 in 55 years. Buy and hold earns you $74, miss the 100 best days, approximately two days a year, and your $74 dwindles down to a miserable $2. Miss the 100 worst days instead of the 100 best days and your $1 becomes $2,908. Miss 'em both? In the absence of the 100 best and 100 worst days, your buck becomes $89.

"We considered only price action in these studies. Dividends would have increased the returns; transactioncosts would have lowered the returns. The annualized returns are: All days: 8.15%. Miss the best 100 days:1.56%. Miss the worst 100 days: 15.6%. Miss the best and the worst 100 days: 8.5%. Do these studies say anything about the seasonal patterns of these dates? Well, yes they do. We have analyzed the occurrences of the worst days, by month and quarter, and the best days, by month and quarter.

"February is the most boring month of the year; it is the perfect candidate for vacations. June is another relatively quiet month. October, however, is the most volatile month from this perspective with 21% of all large days. October, it seems, is a truly interesting month. It has both the largest number of worst days and the largest number of best days. How can that be? The explanation is that October is the month the market most often bottoms in. Some of the worst days are found going into the lows and some of the best days are found coming off the lows. 

"The stock market is struggling. Clearly there is still demand for stocks, a fact that can be confirmed by the market's robust response to Katrina's destruction. This falls squarely onto one of our core precepts, monitoring the market's response to news. In this case, a warm response to bad news is indicative of strong underlying demand. The problem is that we are in the depths of the worst time of the year to own stocks. From a seasonal perspective the time between now and the end of October is a perfectly dismal time for stocks. In the days of old, September had the reputation as the worst month.

"More recently, October has vied for the honor of being considered the most miserable month. Our studies suggest that they should both be avoided on par, or, at the very least, be treated with the respect due a serial killer. With that in mind, we have made a series of reductions in our exposure to stocks to the point where we have raised cash equal to 50% of our holdings. That is a ridiculously high level of cash by Wall Street standards, where anything less than some relatively high percentage (70% to 90%) is dangerously under invested. Their fear is of course that you will miss a big day and thus be stuck underperforming the indexes. However, with ‘the indices’ flat since 1998, the name of the game seems to be intermediate-term market timing and the rule of that game is to protect capital so you can come back and play again tomorrow.

"Some signs of a weakening stock market are the fading of the relative performance by smaller sized stocks, diminishing Net New Highs on the NYSE, a lagging OTC Advance-Decline Line, an increasing High Low Logic Index, negative signals from both the NYSE and OTC High Low indices, a divergence in the number of stocks over their 200-day averages on the NYSE, extreme bullishness in the face of deteriorating market conditions, underperformance of the transportation sector, and so on. The point should be clear. We are sliding into a poor time to own stocks amidst deteriorating market conditions. Could the market right itself and go on to new highs from here? Of course it could, but the odds are against that now. More likely is a pullback leading to a reentry opportunity later on."

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