Seasonality refers to periods of time when market values are subject to and influenced by predictable and repeating yearly patterns. Seasonal effects are important to understand from an analytical perspective as they frequently explain market movements unrelated to current economic or business conditions. It is an essential component for investors to consider when designing their investment strategies.
What Defines A Seasonal Stock
Seasonal stocks are characterized by cyclical demand patterns that occur at various times throughout the year. In other words, they are affected by external factors, such as vacation periods, quarterly earnings releases, or weather conditions.
The retail sector is an excellent example of seasonal stocks, as consumer spending and demand fluctuate during certain points in the year, especially around holiday seasons. As a result, retailers experience higher earnings during these periods, which usually repeat each year.
Seasonality is an important consideration for a company's strategy. It allows critical decisions to be made following the predicted seasonality, such as inventory planning and forecasting, resulting in lowered costs and increased earnings.
It is important to note that seasonal trends vary from cyclical effects in that they are observable exclusively during a calendar year. In contrast, cyclical effects can occur across shorter or longer time periods.
Expedia Group, Inc. (EXPE)
Expedia, which operates in the travel and leisure industry, displays peaks that correspond to holiday seasons, as shown here. Hence, it is safe to conclude that the stock is responsive to seasonal trends.
It is interesting to note that seasonal trend analysis is incompatible with the Efficient Market Hypothesis (EMH). Indeed, the latter states that stocks always move at fair value in the stock market, thus making it impossible for investors to buy undervalued stocks or sell at premium prices. As such, relying on seasonality can be viewed as market timing.
We will now discuss some well-known seasonal trends in the market.
September, or the Beginning of Q3
September has historically been a disappointing period in terms of market returns in the United States. Even after accounting for the massive stock market collapses in 1929, 1987, and 2008, the average monthly return on the S&P 500 Index has been positive for every month except September since 1926.
This seasonal trend can be explained by the fact that September opens the third quarter, which is traditionally the slowest time of year for economic activity and consumer purchasing. As businesses and consumers prepare for the Christmas season, markets begin to recover after September.
The Winter Period
This period encompasses several trends and is frequently characterized by considerable volatility. Due to the Christmas season and hopes of new products for the beginning of the next year, December is generally distinguished by higher sales and earnings. Furthermore, fewer bankruptcies are declared on average during that period.
Nonetheless, many investors sell shares that have lost value near the end of the year in order to deduct capital losses from their tax bills, known as tax-loss selling. This could have a negative impact on the current trend.
In January, there is a conceptual trend for investors to utilize year-end cash bonuses to repurchase stocks at a reduced price (following December's sellout), which usually creates an upward trend during the month. However, while research has demonstrated this effect, the significance appears to have faded over time.
Quarter-end portfolio rebalancing
Stock markets may become notoriously volatile near the conclusion of a fiscal quarter, with the stock values of certain firms shifting direction. This is because institutional and individual investors frequently rebalance their portfolios during these periods.
Portfolio rebalancing entails trading gains in performing assets sold at a high price for underperforming assets, which are purchased at a low price at the end of each quarter.
Weekend effect
The Weekend Effect describes the existence of a pattern in stock market returns that is linked to the specific day of the week. The last days of the week, particularly Fridays, are marked by positive and considerably favorable returns. In contrast, Monday, the first day of the week, stands out from the rest, with an average loss of roughly 1% since 1885.
The Weekend Effect was originally documented in 1973 by Frank Cross in his essay, where he demonstrated that average returns on Fridays were higher than Mondays. This might be due to various causes, including corporations' proclivity to reveal bad news after the bell, short selling, or traders' waning optimism over the weekend.
The Bottom Line
In summary, seasonality in the stock market looks like it causes stocks to rise or fall at specific times of the year, month, or even week. The conclusion of a fiscal year, for example, is frequently marked by volatility and heavy selling as investors liquidate shares that have lost value to deduct capital losses from their tax bill.
When assessing stocks from a fundamental standpoint, it is critical for investors to understand the implications of seasonality since it may substantially influence a company's performance: One could notice that a given company generates larger sales during certain seasons but suffers significant losses in the following cycle. As a result, if seasonality is ignored, an investor may choose to buy or sell assets solely based on prior performance, thus exposing himself to losses in the near future.
Nevertheless, investors should always exercise caution when incorporating seasonal trends in their analytical process. They are not fixed and, depending on the financial climate, may not occur.
Unleash Trading Sucess with Our Groundbreaking Trading Tool, Ebooks, and Masters in Trading Community Access!
Limited Time Access! Only $7!
Find profitable trades with our Profit on Perimeter (POP) Tool for TradingView, available now for just only $7! You'll also get our exclusive bonuses – 2 FREE Ebooks and 14-day access to our premier offering, Masters in Trading Community. Don't wait – this is a limited time offer. Grab this offer now and fuel your trading success!