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US equity market returns in even vs. odd yearsDate: 24 Dec 2013
Equity market is cyclical; moreover, it’s a composition of several cycles – long, medium, and short. To identify these cycles and understand where we are in each of them is a complex research task.
At the same time there is simple idea on the ground that equity returns in even and odd years are different. Here I would provide evidence and explanation of two observations:
EvidenceS&P data for 1951-2012 daily returns (with dividends and splits) was used to prove and illustrate these effects.
You can see visually on the chart below that S&P returns in odd years are usually higher than in preceding or subsequent even years.
On the next chart “Christmas rally” effect is analyzed. It’s more difficult to notice the difference as equity market performance during 11 days on average is not that big, so if you don’t see it below you will see the same in numbers.
1991 Christmas rally generated 7.8% one off return, I made a separate calculation without it.
So during 1951-2012 period:
ExplanationWhat could explain such a behavior? According to Trevor Greetham Fidelity International’s’ director of asset allocation it’s based on global inventory levels. “The inventory cycle typically lasts about two years. ‘Up’ years are good for company profits and equity prices with the inverse true when inventory levels are being drawn down. And over the last decade, Greetham notes, the ‘stocking up’ years have been odd-numbered calendar years while inventory draw-down years have been even-numbered ones.”
To check this I looked at average values for ISM Manufacturing Inventories Index during 1948-2013. The definition of this inventories index is:
“Inventories: reflects the increases and/or decreases in inventory levels”
Note: 2013 data is up to November
As the index changes the behavior since ~1990, the average for two periods was analyzed having in mind that 1990-2013 is more representative.
ISM Manufacturing Inventories Index average
Indeed there is a noticeable difference in even vs. odd years, and this proves the idea that these are inventories levels which define above difference in equity returns.
At the same time the connection is in the opposite direction: inventories grow slowly in odd years vs. even years. This could be interpreted as during years with high economic growth inventories sell out fast and levels are low while when economic growth slows down inventories grow.
ApplicationThese findings suggest the following strategy: buy and hold during odd years (buy Dec 31 even year – sell Dec 31 odd year) and stay out of the market in even. This way historical data assumes that you will get 11% return in the years you invest.
If you are long low frequency investor, the application of this strategy is not that simple as it might look like: where should you keep your money in even years?