Being Street Smart
I call it the ‘monthly strength period’, the strong tendency for the market to be up for the first few days of each month. It’s a pattern that’s been around for a very long-time. Norman Fosback first pointed it out in his 1976 book Stock Market Logic.
However, few investors are aware of its importance.
The history is for the market to average almost half of its monthly gains in just the first three or four days of the month. The last day of the month also often participates because savvy traders pile into the market in anticipation of a similar rally in the first few days of the next month.
The latest example? The S&P 500 was up 29.4 points or 2.3% for the month of January. But guess what?
The gains on just the first four days, and the last day of the month totaled 29.8 points.
In 2009, the S&P 500 was up 23.3% for the year, but the gains on the first three days of each month amounted to 9.2% for the year, 40% of the year’s total gains.
In 2010 the tendency for strength over the first three days of the month was even more obvious.
The S&P 500 gained 142.5 points, or 12.8% for the year. Its gains on just the first three days of each month totaled 228.9 points, or 20.5%. An investor didn’t actually gain anything in 2010 by being invested on other than those first three days each month.
So despite all the time and effort analysts spent last year debating and forecasting the effect on the market that would come from the economic and political changes, the weak economic reports in the summer, the Fed’s QE2 decision, the mid-year elections, corporate earnings, etc., what actually had the most influence; those hotly debated issues, or the Fed, or a simple market pattern?
I have no interest in market patterns that have no clear and reasonable explanation. Don’t talk to me of the ‘super bowl’ indicator, or the history of years ending in 5 tending to be positive years, or ‘As goes January so goes the year.’ Not interested.
The ‘monthly strength period’, like annual seasonality and the Four-Year Presidential Cycle, has a very clear explanation.
Sizable extra chunks of money automatically flow into the market at the end of each month. They come from investors who follow the strategy of dollar-cost averaging into the market on a monthly basis; from the monthly contributions of employees and employers to IRA and 401K plans; monthly dividends on stocks and bonds, most of which are marked for automatic re-investment, etc. (A study some years ago showed that 65% of all preferred-stock dividends and 90% of the interest payments on municipal bonds are paid on either the first or last day of the month, a huge amount of money).
Obviously the pattern is useful in short-term trading. But how is it useful in almost any strategy?
If you’re going to put money in the market for whatever reason and it’s near the end of a month it will usually pay to do so by the last day of the month in order to pick up the extra gains likely in the first few days of the next month. If you’re planning to sell a holding or take money out of a 401K or IRA plan, and it’s near the end of a month, it usually pays to wait for the fourth day of the next month to do so.
Knowledge of the pattern can also be helpful in preventing an emotional reaction to events. I told my subscribers not to react too quickly to the turmoil in Egypt and Friday’s market plunge because “we are now in the period around the end of the month when the market tends to be positive for at least a few days.”
This time around, awareness of the pattern might also prevent investors from being overly optimistic that the market reaction to the turmoil in Egypt only lasted one day. It might be wiser to wait and see what happens after the first three or four days of February.
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