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What is Stock Market Seasonality?

Seasonality is when things change in data in a repeatable and predictable manner. Like summer heat and winter cold, data too, has “seasons” which repeat…

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Seasonality is when things change in data in a repeatable and predictable manner.

Like summer heat and winter cold, data too, has “seasons” which repeat itself predictably. 

There’s seasonality in most datasets, especially in the financial and economic fields. Look at any economic statistic published by the government and you’ll often see the headline figure is “seasonally adjusted,” to remove the seasonal bias. 

Before we move on with technical-speak, lets ensure that we understand seasonality in practical, common sense terms. 

Some things are extremely seasonal and predictable.

Gasoline consumption is seasonal. People tend to travel and go out more in the summer so they buy more gasoline. Save for fluke events like a global pandemic, you can bet on this happening every year.

The above graph is an average demand/price for gasoline in the US on a monthly basis over 20 years of data. As you can see, there’s a predictable rise in the summer over the 20 year period, which repeats itself almost every year.

That is seasonality–a predictable and repeatable trend in data. 

The same is true of retail sales. The holiday season is the biggest time of year for the retail industry and often this one quarter accounts for more than half of a store’s sales. This too, is highly predictable. 

Notice the predictable spikes in retail sales during the holiday season every year from 2015 to 2019. This seasonal trend occurs in recessions and healthy economies. 

In essence, seasonality is simply extracting human behavior patterns from data.

For that reason, it stands to reason that if the seasonal consumption trends of gasoline, home sales, and retail sales are all highly predictable, then perhaps people’s buying and selling of stocks has some predictability. 

And that’s true. There are real socioeconomic factors that affect people’s buying and selling of stocks which occur at regular and predictable intervals which we’ll get into in this article.

But that statement needs a million asterisks and you’ll soon see why. 

The Problem of Seasonality in the Stock Market

While, for instance, gasoline consumption is predictable, that doesn’t mean the future price of gasoline is predictable. So many factors outside of seasonality affect the price of gas that simply betting on seasonality might be profitable, it’ll be very noisy.

Furthermore, the true problem of betting on seasonality in any exchange-traded market comes with the very fact that we’re talking about.

When traders know about predictable seasonal patterns, they make trades based on them.

Let’s do a thought experiment.

Let’s say that gasoline was $1/gallon all year, except that during the summer season, the price goes up $2/gallon. This happens every single year in the same predictable pattern.

Smart traders would begin to take advantage of this by buying the day before summer starts. Their anticipatory buying would slightly push up the price the day before summer starts. So smarter traders would start buying two days before to front-run the price rising.

This would be an iterative process until there was no ability to front-run the summer effect and the price reflected this phenomenon all-year-round, adjusted for the time value of money obviously.

This is what people mean when they say “priced-in.” 

It’s vital to keep in mind that any easily observable seasonality in markets will be to some degree, priced in. This doesn’t mean that you can’t profit from it, you just have to assess how priced in the effect is, and if the risk/reward stands up. 

That all makes sense too. Any time there is a reasonably obvious way to beat the stock market (make better risk-adjusted returns than the broad market), many folks will jump on it until the edge is priced-in.

The stock market is a giant game of chess played by the smartest, richest people in the world, they take advantage of every easy edge there is. 

The Summer Effect: “Sell in May and Go Away”

One of the oldest seasonal tendencies of the stock market is the tendency for weak seasonality in the summer.

Apparently one of the first observations of this effect was a result of traders realizing that London stockbrokers would take extended holidays in the summer, leading to reduced volumes. 

Nowadays the same is true of Wall Street traders and portfolio managers spending more time and mental energy on their summer adventures in the Hamptons and New England. 

So how does the “sell in May” strategy stand up to scrutiny? The easiest way to measure this would be to look at average monthly returns in the S&P 500 for each month of the year: 

As you can see there’s a very observable seasonal effect of summer weakness in the stock market. 

A very simple way to implement this strategy would be to hold stocks from October to April, and sell them in May. This approach has some problems as spending roughly half of the year out of the market could mean that you miss the strongest rallies.

After all, summer weakness is not a rule, it’s simply a statistical tendency. Any given summer in the stock market could be extremely strong, like summer 2020 in tech stocks for example: 

Furthermore, the S&P 500 has, on average, positive returns even during the summer (just weaker than the rest of the year), so you’re missing out on gains by being out of the market. 

The Santa Claus Rally

The Santa Claus Rally is like an annual Christmas gift to the stock market. It refers to the seasonal outperformance of the stock market during the holiday season.

There’s no settled timeframe to define the Santa Claus Rally.

Some start the holiday season the week before Thanksgiving and end the day after New Year’s Day, while others use a much smaller timeframe of the trading days following Christmas Day, ending the day after New Year’s Day. 

There’s no clear-cut reason to explain this seasonal effect, although some theories pertain to end-of-year tax-related trading, or increased investing activity due to holiday bonuses/gifts. Our job isn’t to find why, but to exploit these tendencies for profit. 

This effect is quite similar to “sell in May and go away,” except it focuses solely on the winter months which are the primary source of outperformance.

Here’s a chart  showing S&P 500 seasonal strength during the holiday season from 2000 to 2020: 

The Market Holiday Effect

There’s a strange stock market tendency that leads to outperformance in the days leading to and following market holidays. These don’t have to be major holidays, either, this effect holds true for any day the market is closed, like Memorial Day or President’s Day. 

Note that a ‘market holiday’ in this context means the stock market is closed for that day. 

The trade involves buying the S&P 500 or Dow Jones Industrial Average three trading days prior to a given holiday and holding it three trading days following the holiday. 

Tax Loss Harvesting/Selling Seasonality

One of the more explainable seasonal tendencies in the stock market relates directly to human behavior.

There are real incentives in place to drive this predictable and repeatable piece of human behavior, making this strategy more robust than most in the eyes of many seasonality traders. 

It’s called tax loss harvesting. It’s the tendency for investors to sell their losing investments before the end of the calendar year to realize capital deductible capital losses, while simultaneously replacing them with similar investments. 

For example, let’s say you were betting on oil stocks and owned shares of ExxonMobil (XOM). At the end of the year, you had a $10,000 loss on your Exxon shares.

You’d love to write-off those losses against your taxable income but you’re still bullish on oil stocks. Some investors in this situation might sell Exxon to realize and thus “harvest” the deductible losses, and then replace your Exxon shares with a very similar asset, like say, Chevron (CVX). 

Note that investors cannot simply realize the $10,000 Exxon loss and then just re-buy Exxon shares, that would be considered a “wash sale” and your losses wouldn’t be eligible for deduction. This is why investors will often replace their shares of, say, Exxon, with something similar but not identical like Chevron. 

So essentially the seasonal tendency here is that weak stocks tend to get weaker in the last few weeks of the trading year, and bounce back when the new calendar year starts as investors buy back their old positions. 

Now that you understand why this structural incentive to sell weak stocks at the end of the year exists, let’s look at some simple ways to exploit it. 

One such strategy is to focus on really beaten down small caps, as these tend to represent some people’s biggest portfolio losers. An additional headwind to put in your favor is to focus on stocks with less institutional ownership, as retail investors and traders tend to tax-loss sell more indiscriminately. 

So the basic concept here is to find small-cap stocks with low institutional ownership that were really beaten down on the year. 

Bottom Line

While seasonal trading is mainstream and a well-accepted form of alpha in the commodities world, it’s still a red-headed step child in the stock market world.

The seasonality of commodities is obvious to everyone; grains have their harvest season, gasoline consumption has well-established consumption trends, and so on. It’s not so clear in the stock market. 

But it’s quite clear that seasonality does exist in the stock market, it’s just harder to find and even harder to explain.

The catch here is that when a trading advantage is more esoteric and less widely accepted, it also tends to be more profitable.

The post What is Stock Market Seasonality? appeared first on Warrior Trading.

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…

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Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

cpi inflation

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

unemployment and recession

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

jobs employment recession

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

corporate bonds financial stability

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’
  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS
  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES
  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.
  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch
  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

The post Will Powell Pivot? Don’t Count On It appeared first on RIA.

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Spread & Containment

Why You Should Not Worry About Disney and Netflix Stock

The two streaming giants have struggled but investors should not be too concerned.

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The two streaming giants have struggled but investors should not be too concerned.

During the lockdown/quarantine days of the pandemic, we all apparently rode our Peloton (PTON) - Get Peloton Interactive Inc. Report bikes while binge-watching streaming videos. As soon as we finished that, we headed onto a Zoom Video  (ZM) - Get Zoom Video Communications Inc. Report call, presumably before ordering food delivery and later having a Teladoc (TDOC) - Get Teladoc Health Inc. Report appointment

That may not have actually been your direct experience, but it's how the stock market performed. People bought so-called "stay-at-home" stocks because we all were, well, stuck at home. Of course, at some point we weren't stuck at home, and sentiment on those stocks changed.

The challenge for investors is sorting out the real narrative from the false one. 

At-home-exercise bikes were never going to replace gyms once people could go out again, and the audience for a premium-priced product was limited when gym memberships can cost as little as $10 a month.

Telemedicine has a bright future, but it has limits and it may prove an area where the brand name does not matter.

Streaming video is different, however, and while Netflix (NFLX) - Get Netflix Inc. Report and Walt Disney (DIS) - Get The Walt Disney Company Report stock are down roughly 40% and 55% respectively over the past 12 months, there are a lot of reasons shareholders need not be concerned.

Netflix/TS

Netflix Has a Correctible Problem  

While Netflix grew steadily for a long time, no product has an endless upward trajectory. The company lost subscribers in its most recent quarter, but that comes after it added more than 36 million customers in 2020 and another 18 million in 2021. Even with its Q2 2022 drop of about a million subscribers, the company still has 220 million paying customers.

That's a huge number and it's not likely to get all that much bigger or all that much smaller over the next few years. The reality is that Netflix has left its growth phase and has moved into its fiscal responsibility phase.

Now, instead of producing $200 million movies and throwing them at the wall, the company has to be smarter about its content investments.

"So our content expense will continue to grow, but it's more moderated as we adjusted for the growth in our revenue," Chief Financial Officer Spence Neumann said during the company's second-quarter-earnings call.

"And we think we've gotten a lot smarter over the last decade or so being in the originals business as to where we can direct our spend for most impact, highest impact, and highest satisfaction for our members." 

Nobody at Netflix wants to say "we're going to make fewer shows and focus on having hits," but Netflix has reached the retention stage of its business. It needs to have enough content its customers want to see coming up to keep people from quitting.

That may not be an easy transition, but it's one the company is likely to make, where it can be comfortably profitable around its current customer base. 

Disney Has Nothing to Worry About     

Disney is obviously much more than a streaming company, but Disney+ has been a massive driver for the company. Its growth was accelerated by the pandemic, but every family and any adults who like Marvel and Star Wars were always going to subscribe.

Fans of the company's huge franchises are simply not going to skip the biggest shows coming out of those universes. 

Disney, unlike Netflix, does not have a too-much-content problem. It knows its customer base and understands that while "Falcon and the Winter Soldier" might draw a bigger audience than "Ms. Marvel," both drive audience to the service.

Disney may struggle with what's a theatrical release and what goes to streaming, but it has hit franchises that have stood the test of time. That's not going to change just because lockdowns have ended and we have other entertainment choices.

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Stocks

Bed Bath & Beyond stock should be worth $4 only: Baird

Bed Bath & Beyond Inc (NASDAQ: BBBY) has been on fire over the past couple of weeks, but that “frenzy” is unlikely to last for very long, says…

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Bed Bath & Beyond Inc (NASDAQ: BBBY) has been on fire over the past couple of weeks, but that “frenzy” is unlikely to last for very long, says Justin Kleber. He’s a Senior Equity Research Analyst at Baird.

Bed Bath & Beyond stock could tank 55% from here

On Tuesday, he downgraded the Bed Bath & Beyond stock to “underperform” and reiterated his price target of $4.0 a share that represents about a 55% downside from here. In a note to clients, Kleber said:

This frenzied move has been driven by non-fundamentally focused market participants. With market share losses accelerating and BBBY burning cash, fundamental risk/reward looks unattractive.

The meme stock, he added, has to sharply improve its EBITDA to justify its current $2.30 billion enterprise value – but that’s unlikely to happen in this macroeconomic environment.

Versus its year-to-date low, Bed bath & Beyond stock is currently up more than 100%.

Why else does he dislike Bed Bath & Beyond Inc?

In its latest reported quarter, the American chain of domestic merchandise retail stores lost $2.83 a share (adjusted) – more than double the $1.39 that analysts had expected. Kleber is also bearish on the Bed Bath & Beyond stock because:

Supply chain disruptions have exposed BBBY’s antiquated infrastructure and wreaked havoc on the business at the same time the company’s pivot toward owned brands has not resonated with customers.

The retailer will likely remain challenged as demand for home goods continues to normalise following two years of pandemic-driven boost, he concluded.

In June, the Union-headquartered company named Sue Gove its new CEO (interim) tasked with fixing the liquidity concerns. Most recently, Bed Bath & Beyond was reported considering private loans to optimise its balance sheet.

The post Bed Bath & Beyond stock should be worth $4 only: Baird appeared first on Invezz.

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