Certain simple calendar anomalies seem to persist. This may be hard to believe as sophisticated as finance has become, but the data supports it. Plus, one of the stronger ones around the 4th July holiday is fast approaching. These moves are never guaranteed, but historically investors have come out ahead, over time and on average, with certain of them.
Early July
The first week of July is among the best of all calendar periods for the both the Dow, the UK’s FTSE-350 index as researchers at the Federal Reserve Bank of Atlanta show here. This is arguably due to the interplay of two calendar anomalies for investors.
The first is what’s called the turn of the month effect, whereby markets tend to deliver better performance in the first few days of the month. Precise definitions vary, but typically from the last day of the prior month to the 4th day of the subsequent month. In fact, some studies, such as this one from researchers at Purdue suggest that substantially all the returns from stocks occur during the first few days of the month. More recently, researchers at Robeco Quantitative investments found that the turn of the month effect was one of only two fundamental calendar effects in the market. The other is the Halloween indicator. Why does this occur? Research is less clear on the drivers of this phenomenon, but the need for liquidity at the turn of the month could be a factor according to this study.
The second is the holiday effect, due to this markets tend to lift right before holidays such as the 4th of July holiday, though it can apply to Memorial Day, Christmas and New Year too. Robert Ariel documents this trend here.
This week there’s a double benefit because we see both a holiday effect and a turn of the month effect, which may be why the Atlanta Fed’s study showed a superior return for the market over this periods historically.
Issues And Risks
There are a few things to bear in mind with these strategies. The first are taxes. These strategies necessarily involve shorter term trading. That means you may be subject to short-term capital gains tax, that can eat into your returns relative to buy-and-hold strategies where long-term capital gains can attract a lower rate of tax, or none at all. Of course, if you have a tax-sheltered account, such as an IRA of 401(k) this is less of a consideration.
The second is discipline. These trading rules have historically offered positive outcomes on average, but the gains from any particular trade are both uncertain and relatively small. Therefore, implementing the strategy correctly requires discipline both to implement the strategy absolutely correctly an stick to it despite what the market is doing.
Another important observation right now is the market valuation is high as is potential economic risk. Even though these strategies may offer incremental gains, they could easily be drowned out by COVID-19 related events and newsflow in the current environment. Of course, theory implies you’ll come out over time on average, but the swings in the current market have been pronounced and the VIX as a forward-looking volatility-indicator does remain elevated.
Finally, of course, with many of these anomalies as they become more popular, the gains tend to recede. There is evidence that the markets evolve over time and what was easy money becomes harder to come by in future years. Still these calendar effects have tended to persist over long stretches of history.
