It’s a commonly held belief among value investors that markets are often inefficient, that market participants are often irrational and that price does not always reflect value. I believe this too. There are plenty of things that cause such deviations - euphoria, distress, panic and so on. But did you know that the time of year can also have an effect on prices? I recently came across this research note from Morgan Stanley (MS, Financial) that discussed the phenomenon of higher-than-average stock market returns at the end of the year.
'Tis the season
It’s true, and it’s been this way for over 70 years: November and December have some of the highest average monthly returns. By contrast, February, June and September have the lowest. This holds for both U.S. and non-U.S. stock markets. Why does this happen?
“There are a variety of theories as to why stock markets tend to do better at year-end, from holiday cheer to investors starting to buy the stocks they want to own for the year ahead a little early. It seems almost silly that in an era of immense data and computing power, a major focus of investors and a driver of returns is the position of the Earth relative to the Sun.”
If this isn’t evidence that markets exhibit systemic inefficiency, I don’t know what is. There is, of course, nothing inherent to winter that should make asset prices rise, and the data clearly shows there is at least a correlation between these two things. Perhaps the optimism of the holiday season makes investors commit more capital than they otherwise would. Or maybe investors have fewer things to do during the cold months and get restless. Who knows?
With all that being said, however, there are other things to consider before loading up on stocks in November and December. According to data provided by Morgan Stanley, the average gain for these two months is around 3% - good, but not world-beating. Furthermore:
“While markets have risen about 70% of the time in December, that that means they’ve still fallen about 30% of the time. Some of these declines have been quite notable: with 2001, 2002, 2007 and 2008 all years that saw a very tough finish. And, of course, don’t forget last year, when stocks fell sharply in November, and then had an even worse close to the year.”
In other words, while this effect definitely does exist, there are other considerations - like recession or global financial meltdown - that can overshadow it. I think the lesson to be learned here - apart from the fact that markets are inefficient - is to take what data and statistics tell you with a pinch of salt. While it’s true that they can help us uncover useful and interesting patterns, we must also be careful not to ascribe them too much importance. Sometimes, it really is better to use your own common sense.
Read more here:
- How Does an Initial Public Offering Actually Work?
- Jack Bogle: The Stock Market Is a Giant Distraction
- Howard Marks: Successful Investors Have This Attribute
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