Earlier on, we have discussed some well-known stock market effects connected to investing in the stock markets in specific months of the year, the possible explanations for these effects as well as the results of our analysis from our study in Part I (Is there a best month to invest?).
In this second instalment of our two-part article, we attempt to find out whether there exists a specific quarter within a calendar year where evidence shows that it is a better time to invest your money, based on the probability of seeing stronger returns compared against that of other calendar quarters.
Is there a best or worst quarter at all?
Many countries experience seasonal changes over different quarters of the year, some affecting economic data such as the rise in the price of oil in winter. Another observation would be: contrary to the Asians, Westerners tend to take longer breaks during spring or in the May-to-July period; these could be the reasons for the quieter-than-usual market activities in these periods. We thought it would be interesting to find out if these differences were obvious in the past 18 years.
Source: Fundsupermart.com compilations, Bloomberg
Chart 1 shows the probability of posting a positive return in a specific calendar quarter for the STI as well as that of a basket of five indices, including the S&P500, DJ Stoxx 50, Nikkei 225, MSCI Asia ex-Japan and the STI. From our analysis, we discovered that the chances for the STI to have positive returns were the highest in the 4th quarter of the year (at a probability of 77.8%). Consistent with the findings that investors tend to lose money from their investments in the Singaporean equity market in the months of August and September, our results also show that there was only a one-third chance of making money in the local bourse in the 3rd quarter.
Following these observations, does it necessarily mean that staying out of the markets in the 3rd quarter of the year, and remaining invested in the 4th quarter will definitely deliver higher returns to the investors? Aside from deriving at the probabilities of markets generating positive returns, we have also calculated the average level of returns in each of the four quarters.
Table 1 shows that the average return for the 4th quarters within the period 1989 to 2006 are at the highest level for the basket of five indices we cover, averaging 6.3%. Notably, the STI posted strong returns of 9.7% in the 4th quarter. In addition, the rest of the indices which we cover also saw strong returns in the 4th quarter on average, except for the Nikkei 225 Index. The Japanese stock index only returned an average of 0.6% - similar to its average returns in the 1st quarter.
In general, the results tell us that the 4th quarter seems to deliver the highest returns among all other quarters. What could be the reasons for this? In the first instalment of this article, we observed that the month of December posts the strongest returns relative to the other months, perhaps due to what is known as the "Santa Claus Rally". This theory states that there is a tendency for stock prices to surge in the week around Christmas and New Year. Explanations offered for this phenomenon include tax considerations, positive sentiment in the Wall Street, and people investing their New Year bonuses. A more plausible explanation is that many consider the 'Santa Claus Rally' to be the result of people buying stocks in anticipation of the rise in stock prices in the month of January, known as the "January Effect".
In contrast, the 3rd quarter seems to be the period when investors face the highest probability of losing money. Investment returns over this period were negative on average. A more obvious time of the year would be the month of August where investors faced the highest probability of having negative returns. Based on historical data, investors would have seen their investments shrink 2.3% if they had invested in all the 3rd quarters within our period of study from 1989 to 2006. Also, none of the indices we covered in this study had shown a positive return in the 3rd quarter on average. So, is this sufficient to conclude that investors should avoid investing in the 3rd quarter of each year?
The answer is likely to be a 'No', because even in the 3rd quarter, markets may also show strong variability in terms of their performance. In this sense, it may also be possible for markets to generate a decent level of returns in the 3rd quarter. An example would be the 3rd quarter of 2006, when the STI and the MSCI Asia ex-Japan Index returned 5.5% and 6.4% respectively. Of course, 2006 was a year when many Asian economies enjoyed strong growth and positive market sentiment. As such, market factors also play an important part in determining whether the 3rd quarter of a year will post a positive return.
In fact, there were also examples when markets saw large negative returns in the 4th quarter of a year. Chart 2 shows the probability of the 3rd quarter performing better than the 4th quarter for the various indices covered from 1989 to 2006. Our study shows that out of every 10 occasions, there will be 4 where the 3rd quarter returns would have outperformed those in the 4th quarter on average.
On the other hand, Chart 3 shows the quarterly highs and lows, over the past 18 years, for the indices we cover. From the chart, the MSCI Asia ex-Japan Index dipped 23.8% in the 4th quarter during the 1997 Asian Financial Crisis, even though the 4th quarter is supposed to be the quarter which would usually generate the best returns. And in the 3rd quarter of 2003, the Nikkei 225 Index was up 19%, even though the 3rd quarter has historically been seen to deliver the lowest returns.
From the results, investors may be worried over the STI's volatility, as it has contributed to two of the most-negative quarterly returns and two of the most-positive quarterly returns. Our views, however, are that this is well within our expectations as a single-country index. Single country indices, as opposed to regional indices, usually tend to exhibit a higher level of volatility. In fact, one of the limitations of our study lies in the limited number of markets or indices that we include, while the rest of the Asian markets were not extensively covered.
Limitations to our study
As with other analyses, there are also certain limitations to our research - one of which is the limited period of the study (from 1989 to 2006). Essentially, there are 2 reasons for choosing this period. Firstly, we believe data from the earlier years may not be as relevant because the financial markets have undergone various developments in the recent years. The implementation of new trading mechanisms, such as the circuit breakers, by some stock exchanges to prevent panic-selling, is one such example. Due to this, data from 1987 onwards will show less volatility on the downside as a result. Secondly, the data from the period 1989 to 2006 have captured significant market events such as the Asian Financial Crisis (1997 to 1998), the bursting of the Technology Bubble (2000 to 2002) as well as the bursting of the Japanese Asset Bubble (1990 to 1992).
Another limitation is relevant to the stock indices that we include in our study. Our analysis was mainly based on the regional market indices; apart from the STI, we have not considered other country-specific indices in this study as we have always advocated the investment principle of holding both the core and supplementary portions in an investment portfolio. Our recommendation is that 80% of your investments should be included in the core portionof your portfolio; these should include the following major regional markets: US (S&P 500 Index), Europe (DJ Stoxx 50 Index), Japan (Nikkei 225 Index), and Asia ex-Japan (MSCI Asia ex-Japan Index). As a result, our research has been focused on the indices representing these markets, which are part of the core portion.
To sum it all
We discovered that the 3rd quarter is the calendar quarter of the year which tends to deliever the worst level of returns, while the 4th quarter generates the best returns. However, it is essential to understand that timing the market in such a manner will be difficult because there still exist differences in trends over different calendar years. A good example would be the period during which the Asian Financial Crisis (1997 to 1998) had occurred and the bursting of the Technology Bubble in the years 2001 to 2002. If you have stayed invested during these periods, it would not have mattered which quarter you had invested in - your returns would probably not be strong, or would even have been in red!
From our findings, it is difficult to just buy into a particular market and expect higher returns, merely based on the historical probability that it would perform well in a particular month or quarter. Much still hinges on the fundamentals of a particular equity market at a certain point in time. If a market has weak fundamentals in a particular year, it would matter less which time of the year you invest in it, as more likely than not, the market would still not do well within that calendar year anyway. Another possible cause for concern when you attempt to time the market relates to the transaction costs involved. If you just buy and sell based on the perceived 'best month' or 'best quarter', you will trade more often, leading to an increase in your overall transaction costs incurred.
Thus, analysing the fundamentals of an equity market, rather than betting on the best month or quarter remains the best approach for investing. These fundamentals include the markets' estimated price-to-earnings ratio (PE ratio), earnings growth, economic fundamentals, currency factors as well as long-term economic growth.
Mah Ching Cheng (Research Manager, AFP & Financial Adviser Representative) is part of the Research team at Fundsupermart.com, a division of iFAST Financial Pte Ltd.
Fundsupermart.com is Singapore's largest online distributor of unit trusts, and is the online distribution arm of iFAST Financial Pte Ltd. iFAST Financial is a holder of the Capital Markets Services License and Financial Adviser's license by the Monetary Authority of Singapore and is a CPFIS Registered Investment Administrator (IA).
No investment decision should be taken without first viewing a fund's prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice.
