Benefiting from calendar effects
Laurens Swinkels, Pim van Vliet, PhD
For decades academic researchers and investors have been fascinated by investment strategies that deliver extra returns simply by making use of the familiar calendar effects. A clever strategy will allow substantial profits to be made.
Recent research by Robeco shows that in the period examined, there was a positive return on stocks of 7.2% (on top of the risk-free interest rate) when there was a Halloween or TOM effect, against a negative return of -2.8% in all other cases.
Calendar effects cause stocks to perform better at certain times or on specific days than on others. There are different explanations for this, most of them psychological (‘behavioral’). They explain the holiday effect, for example, by increased optimism in the run-up to a free day or a long weekend.
In an article published in the Journal of Asset Management recently, Laurens Swinkels and Pim van Vliet study the connection between these effects to establish which of them - or indeed which combination - could be most profitable. They focus on the five most common effects: the Halloween, January, turn-of-the-month, weekend and holiday effects. A brief explanation of these effects is given below.
The Halloween effect
The Halloween effect is a variant of the familiar stock-market adage: “Sell in May and go away, but remember to come back in September”. This is based on the assumption that stock markets perform better from the beginning of November (Halloween is on 31 October) through April than during the rest of the year.
The January effect
This effect refers to a general rise in stock prices in January. This usually follows a decline in prices that typically takes place in December when investors sell their assets in order to create losses at the end of the year for tax purposes.
Turn-of-the-month (TOM) effect
This effect means that stocks systematically perform better around the turn of the month (defined as the time from the last trading day in a month through to the fourth trading day of the following month).
The weekend effect
This is the phenomenon where stock-price returns on a Monday tend to be much lower than they were on the Friday before.
The holiday effect
The holiday effect implies that stock prices tend to rise in the run-up to holidays in the United States (e.g. Independence Day or Thanksgiving).
At first sight, it would seem that these effects are isolated. However, as some of them coincide on certain days, there could well be a connection. For instance, the end of one month and the beginning of the next sometimes fall in a weekend, so that the TOM and weekend effects overlap. If this is not taken into account, investors may run the risk of overestimating the potential profitability of the calendar effects. Swinkels and Van Vliet therefore examined the interaction between these effects. They used the daily return figures on the US equity market in the period 1 July 1963 to 31 December 2008 as a basis.
Their research revealed that the Halloween and TOM effects are the strongest and most profitable effects. A clever strategy will allow substantial profits to be made. In the period examined, the positive return on stocks was 7.2% (on top of the risk-free interest rate) when there was a Halloween or TOM effect, against a negative return of -2.8% in all other cases. An investment strategy based on these two effects delivers higher risk-adjusted net returns than a passive ‘buy-and-hold’ strategy. This holds true for different periods, market segments and international stock markets.
Even when transaction costs of 0.20% are included, a strategy based on Halloween and TOM effects performs better than the stock market as a whole. When other effects are taken into account, they only reduce returns because of the increased transaction costs. If the transaction costs are assumed to be higher (0.30%), then the strategy based only on the Halloween effect shows the best performance.
The complete paper by Swinkels and Van Vliet can be found here.