Seasonality

1 10 COVERMay 2005 ) Seasonal Trend in Heating Oil PriceHeating oil prices were least expensive in June and July. Increasedpurchases caused prices to rise until they reached their peak during theheating season from October through ) Construction of a Seasonal ChartSeasonal Charts do not show prices over a certain time period, but insteadshow price progression averaged over the course of a certain time : : Trend inHeating Oil PriceMost expensivefrom October untilJanuary(heating season)The rising price beganas early as mid-summer(initial purchases)Cheapest in June and JulyJan FebMarAprMay JunJulAugSep OctNov10310210110099989796959493929190 Dec1401301201101009080 Year #4 Year #3 Year #2 Year #1 Seasonal of aSeasonal Chart(schematic)JanFebMarAprMay JunJulAugSep OctNov DecWhat is Seasonality ? Seasonality is a seasonal fluctuation or cycle forming a progression ortrend. The best-known seasonal progression is the outdoortemperature. The prices of goods are subject to seasonal tendenciesas a result of natural processes , harvest or cold weather periodsoccurring at various times of the year.

2 For example, oil is less expensivein summer than in winter during the heating season. Financial marketsalso have seasonal patterns as various calendrical occurrences comeinto play. These include familiar events like dividend payments oncertain dates or on lesser-known phenomena like mood improvementprior to holidays. In a greater sense, Seasonality also includes timespans other than those based on the calendar year, , intradayseasonality. In addition, volatility also shows traceable is popular in the heating oil market. Many homeownersand building managers cover their fuel needs before the heatingseason begins leading to early price increases. This demonstrates howimportant it is to conduct empirical studies and evaluations on seasonaltrends and not be swayed by preconceived ideas about seasons are a big influential factor in the commodities and financialmarkets. They influence the probability of price movement, whilst workingin the background often unobserved.

3 This article will demonstrate differentways traders can utilise seasonal patterns and to what they should payparticular ) Seasonal Course of the Dow JonesPrices increase on average through the beginning of June before pausingor decreasing. Rising prices generally return again in : MarAprMay JunJulAug SepOctNovDecSeasonal ChartsSeasonal trends are best displayed on seasonal charts. Seasonal chartsdiffer to conventional charts in that they do not show prices over acertain time period, but instead show price progression averaged overthe course of a certain time frame. If the mean price of all previouslysampled time-periods increases during , a certain time of year, itshows on the seasonal chart as a rising trend in those months. Thehorizontal axis is the time scale (often one year), the vertical axisdisplays price information frequently as a percentage constructed seasonal charts show the exact daily priceprogression and filter out calendrical irregularities like holidays.

4 Theannualised percentage return of a seasonal trading strategy can beeasily calculated right from the chart. A well-versed practitioner cancreate a basic seasonal chart using a spreadsheet for a roughassessment of a seasonal Yearly Course of the Dow JonesFigure 3 shows the seasonal course of the Dow Jones over a 34-yearperiod. A regular seasonal upwards-trend can be seen starting in lateOctober and continuing through the beginning of June. The indexshows an average price decrease for the remaining period from Juneuntil the end of the sampled time period (October 1970 through October2004) an investor could have captured 14107 Dow points if he wasinvested only during the seasonally positive phases between October27, and June 6. 29 of the 34 tested years would have been profitableduring this period. An investment during the seasonally negativeperiod from June 6, through October 27, would have produced a lossof 4860 points. That s an average profit of during the goodphases compared with a loss of during the seasonally badcycles, which resulted despite the long bull market during theseyears.

5 By investing only in seasonally favourable times, investmentcapital is available for alternative investments during negativephases. A buy and hold strategy over the 34 year period yielded areturn of Seasonal Tendencies of US BondsThe Bond market offers a place to park money when stocks areseasonally negative, as bonds often show seasonal trends oppositethe equity markets. The reason is probably the alternating seasonalrelationship of the stock and bond markets (capital redeployment,alternating attractiveness of bonds and stocks, etc.). Figure 4 showsthe seasonal course of a bond investment. The swings here appearsmall because of constantly flowing interest income. Nevertheless,the relative weakness in the first part of the year is easily recognisablefollowed by strength in the remaining months. One could say forbonds, Buy in May . Sell in May and Go Away This leads us back to the stock market.

6 The seasonal chart of the DowJones gives us the opportunity to test one of the stock market s oldestDJIA Seasonal 34 YearsF4) Bond s Seasonal CourseAs opposed to the stock market, bonds become attractive in : JunJulAug SepOct NovDec108107106105104103102101100US Bonds 10Y(Total Return Index)Seasonal 35 YearsF5) Long-term seasonal course of the Dow JonesThis shows the seasonal course of the Dow Jones Industrial Average overthe entire available time span from 1896 through the : MarAprMay JunJulAug SepOctNovDecDow Jones IASeasonal 109 Years12 COVERMay 2005 ) Year-End Rally, Performance S&PFigure 6 shows the results of each of the last 20 year-end ,842,877,522,441,048,57-3,25-0,431,751,2 10,344,470,069,191,992,691,385,462,21-1, 62-1,2485/8686/8787/8888/8989/9090/9191/ 9292/9393/9494/9595/9696/9797/9898/9999/ 0000/0101/0202/0303/0404/05 OSource: , Sell in May and go away . The saying, originally coined in GreatBritain, isn t precise enough for today s markets.

7 An examination ofthe US indices would actually indicate selling somewhat , it is astounding that seasonal weakness still occurs afterMay. The adage serves to reminds us, however that seasonalprogressions can change and should always be examined forconsistency and SeasonalityA strong indication of a stable seasonal cycle is its observance over along period of time. This reduces the chance of circumstantial pricechanges skewing the yearly seasonal chart. The long-term view alsoindicates that basic fundamentals are likely behind the yearly 5 again shows the yearly course of the Dow Jones, this timeover the entire available time span from 1896 through the weakness in September is clearly observable over the long-term. The same goes for the strength in the first part of the interesting is the strength from the middle of Decemberthrough the beginning of January, the year-end- or Santa chart clearly shows its proportionally steep is a Seasonal Pattern?

8 An entire seasonal cycle cannot be traded, but a single seasonalpattern can. A seasonal pattern is an identifiable seasonal movementbetween two dates. A high occurrence probability, timeliness, and asolid fundamental reason for the movement are desirable. Seasonalpatterns can be short-, medium-, or long-term in nature and canoverlap as well. In addition, statistical conclusions can really only bedrawn in connection with single seasonal Year-End RallyA succinct seasonal pattern in the US stock market is the year-endrally. It begins on December 12, and ends on January 7, the followingyear. In the S&P 500, the definitive index for futures, there was a priceincrease between these two dates in 16 of the last 20 years. Theaverage gain was Losses occurred only four times and averagedjust In total the S&P rose on average during the 20-year just during these 15 trading days. Figure 6 shows the results ofeach of the last 20 year-end US DollarAnother lesser-known year-end seasonal pattern can be found in theUS Dollar.

9 The Chart in Figure 7 shows the seasonal course of the Euro/Dollar Forex rate over the last 33 years including the year 2004. Clearlythe Euro rises seasonally through the end of December beforereversing course around the new-year and falling through the end ofJanuary. Money flows out of the Dollar as the year changes only toturn and flow back. The reason is thought to be the year-end deadlinefor financial , the Euro stayed solid through December 2004, as themood for the Dollar remained bearish. Few market observers couldimagine a stronger Dollar considering the high Balance of Paymentsdeficit and the US currency s established down trend. Nevertheless atrend change took place just as the new-year began, surprising many,except those using seasonal trend analysis. They had anticipated thetrend reversal at exactly this Period LengthsSeasonal progressions are also measured in time frames other thanone year (also known as cycles). Intraday-sesaonality is a short-termoccurrence worth mentioning.

10 The S&P 500 has intraday patternsmoving as much as one-tenth of a percent. That s not only interestingfor day traders, but also for position traders trying to improve entryand exit points. Weekly and monthly perspectives are also worth alook. It was noted decades ago that years ending in 5 ( , 1905), areusually solid market years in the ten-year cycle, the reasons, howeverremain unknown. The cause of the four-year- or election cycle is moreobvious. US Presidents want to be re-elected or favour a candidatefrom their own party to take their place. They, as well as the FederalReserve, try and ensure the economy runs smoothly before theS&P 500 Year-End RallyDec. 15 - Jan. 7, since 1985 Performance in %F7) Euro / US DollarThis chart shows the Seasonal Course of the Euro/US DollarSource: JunJulAug SepOctNovDecEURO/USD Seasonal 33 Years14 COVERMay 2005 ) Four-Year Election Cycle, Dow JonesThe course of the Dow Jones according to the year within the electioncycle over a span of about 100 : Unpopular measures are usually held until after the Four-Year Election Cycle in the US Stock MarketThe course of the stock market is hardly dependent on whether aRepublican or a Democrat becomes President.