Money Brain: This is the best month to buy stocks

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What are the best and worst months to buy stocks? For answers, investors have ransacked past stock returns, looking for patterns. Investopedia advises that, “The average return in October is positive historically, despite the record drops of 19.7% and 21.5% in 1929 and 1987.” The so-called January Effect argues for buying in December. The Santa Claus Rally argues for buying in November. As for selling, some say, “Sell in May and go away.” Others believe that August and September are the worst months for stocks.

Such advice is wishful thinking by hopeful investors searching for an elusive way to time the market. The inconvenient truth is that there can be no permanent best or worst month. If December was the most profitable month for stocks, people would buy in November, temporarily making November the best month — causing people to buy in October, and so on. Any regular pattern is bound to self-destruct.

Stock prices don’t go up or down because today is different from yesterday, but because today is not what the market expected it to be — the market is surprised. By definition, surprises cannot be predicted; neither can short-term price movements.

There is no reason for a monthly pattern in stock prices.

Since there is no reason for a monthly pattern in surprises, there is no reason for a monthly pattern in stock prices. The inevitable patterns that are discovered by scrutinizing the past are nothing more than temporary coincidences. In the 1990s, December was the best month for the stock market. In the 2000s, April was the best month, and December was a nothing-burger (the sixth-best month). So far, in the 2010s, October has been the best month and April has been seventh-best. These calculations of the best-months in the past are about as useful as calculating the average telephone number.

Yet it doesn’t stop people from making such tabulations and believing their calculations are meaningful. A February report from J. P. Morgan’s North America Equity Research group was headlined, “Seasonality Shows Now Is the Time to Buy U. S. Gaming Stocks.” The authors looked at the monthly returns for gaming stocks back to January 2000 and concluded that, “Now is the time to buy, in our view. Historically, March and April have been the best months to own U.S. gaming stocks.”

If monthly returns bounce around, some months are bound to have higher returns than other months, just by chance. That is the nature of the beast we call the stock market. Identifying which month happened to have had the highest return at some point in the past proves nothing at all.

Read: Here’s the real indicator of stock-market success.

To demonstrate this, I looked at all of the monthly S&P 500 SPX, -0.72%  returns for the 18-year period from January 2000 through December 2017 and shuffled these 216 returns randomly into 12 monthly categories I call pseudo-months. Each pseudo-month has 18 monthly returns that are equally likely to have come from any of the real months. A return in the first pseudo-month is as likely to be a June return as a January return. Then, I calculated the average annualized return for each pseudo-month. Sure enough, some the average returns in some pseudo-months were much higher than in others.

I repeated this experiment one million times. The average annualized monthly return over this 18-year period was 6.46%. In 84% of the simulations, there was at least one pseudo-month with an average annualized return above 20%. In 17% of the simulations, there was at least one pseudo-month with an average annualized return above 30%. In 42% of the simulations, the difference between the average returns for the best and worst months was greater than 40%.

Remember, these are not real months. They are pseudo-months. Yes, some pseudo-months have higher average returns than others. That observation is inevitable, and useless, as is any recommendation to buy any stocks based on the month of the year.

My advice, with a nod to Mark Twain: “March can be a good month to invest in stocks. Other good months are July, January, September, April, November, May, October, June, December, August and February.”

Gary Smith is the Fletcher Jones Professor of Economics at Pomona College and author of “Money Machine: The Surprisingly Simple Power of Value Investing.” (AMACOM, 2017)

 

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