December has proven to be the biggest month for stock markets all over the world.
Stephen Eckett, author of The UK Stock Market Almanac 2014, has examined a number of theories that claim to explain this anomaly.
“I don’t go along with this theory, but one theory is that fund managers throughout the year invest in all sorts of stocks,” Eckett told StreetID. “When they share reports at the end of the year, these reports will carry a record of what their portfolios are holding.”
Thus, hedge fund managers might decide to tidy up their portfolios and throw out any embarrassing investments that did not pan out. They will then switch into “nice, sensible stocks,” the theory claims.
“In the old days, you always switched into IBM,” said Eckett. “Now, you’d be switching into Apple or Google or something like that. So that’s one argument for why the market goes up.”
Another argument is related to the six-month effect.
“What that says — and this is one of the remarkable anomalies in the stock market — is that [the period] from the beginning of November to the end of April vastly outperforms the market over the period of May to the end of October,” said Eckett. “It is absolutely extraordinary.”
For example, if you look at one $1,000 portfolio that only invests from May to October, its value may barely change over a 30-year period. If you look at another $1,000 portfolio that only invests from November to April, it could be worth $20,000 over a 30-year period.
“It’s a remarkable thing,” said Eckett. “The trend is that stock markets are weakest up to the end of October, and then in November they take off.”
The whole “sell in May, go away” philosophy may be another reason for December’s success.
But those are not the only possible explanations. Seasonal Affective Disorder (“SAD” for short) may also be the cause, as it could impact investors’ willingness to take on risk.
Under that theory, Eckett said that in March and April (when the days are getting longer), people begin to have a more positive outlook on things. This inspires them to invest and take more risks. In doing so, stock prices increase. By the time May arrives, the prices have already been bid up fairly high, leading to summer declines.
When September and October arrive, the opposite occurs. The days get shorter, people feel less positive and are less willing to take risks. This artificially depresses prices at the end of October, paving the way for a rise in December.
None of these theories have proven to be the sole cause for the December spike, but they provide some interesting insights into why hedge fund managers (and everyday investors) favor the last month of the year.
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