Slash Your Risk and Boost Your Profits
No summer vacation for your portfolio! That was the message of my last column, “Sell in May... Please Go Away.”
Every year at this time, the talking heads warn us to sell our stocks and not reload until the arrival of the Great Pumpkin. It’s a lot of needless selling just to miss the summer doldrums.
Although it hasn’t been the worst advice I’ve heard over the last decade, the Sell-In-May strategy can be a loser after factoring in dividends and tax implications.
So does that mean it’s hopeless to use the idea of seasonal investing to boost our returns?
The problem with blindly selling in May is that it misses the fact that not all businesses prosper at the same time of year. Certainly Black Friday is when many retailers turn profitable. But the makers of Itsy Bitsy Teenie Weenie Yellow Polka Dot Bikinis are on fire when it’s hot... not when Santa is hawking a sleigh full of toys.
In other words, the Sell-In-May strategy is too blunt of a tool to take advantage of seasonality. It dumps the stocks of companies that surge while other companies slow.
It’s like trying to do brain surgery with a sledgehammer. Sure, it’s quick and easy. But it rarely turns out well for the patient.
Think what could happen if rather than moving in and out of the market, you moved in and out of stocks that have reciprocal periods of profitability. Now you can put your money to work in every season - not just half the year.
And don’t think this is market timing. It’s not. It’s merely using historical data to pinpoint the strongest periods for individual companies or sectors.
An All-Season Strategy
The Oxford Club’s Emerging Trends Editor Matthew Carr pioneered the techniques it takes to tease out big profits from seasonality. Rather than a mindless all-in/all-out approach, he carefully dissects the market into sectors and stocks that flourish at different times of the year.
So whether it is winter, spring, summer or fall, Matthew’s technique helps him find stocks that historically surge during that time of year. Rather than letting a broad portfolio underperform half the year, he finds the best opportunities to profit year round.
The Prime period is Matthew’s designation for the time of year that a particular stock or sector outperforms. According to Matthew, the period can last from one to eight months.
Look at the revenue chart for Aeropostale (NYSE: ARO). It is clear that the company’s fourth quarter dramatically outperforms the rest of the year.
Since stock prices tend to follow increases in revenue, it’s not surprising that the stock price is cyclical as well. So the time of year the stock is likely to leap with reduced volatility is quite predictable.
According to Matthew, the Prime profit period for Aeropostale (NYSE: ARO) is Oct. 1 through April 30. It tends to prosper until first quarter results squash the enthusiasm generated by the fourth quarter revenue spike.
Take a look at the chart below. It shows the trend perfectly:
I don’t know about you, but the idea that you can use seasonal investing to slash risk is new to me.
Owning stocks when they are rocketing up, and dumping them when they are the most risky, thrills me. And as a skeptic, I am not easily excited (that’s why they made me the Member Advocate).
Boost Your Profits
So what kind of difference can a strategy like Matthew’s make on a stock that year after year goes up during a specific season? Well, the buy-and-hold crowd that snatched up shares of Aeropostale in 2002 turned $10,000 into $72,395. Impressive.
But if Matthew had created his Prime strategy a decade ago, his followers, who only owned Aeropostale during its prime seasons, would have transformed the same $10,000 into $310,632. Way to go, Matt.
Matt’s Prime strategy is more nuanced than just teasing out the prime profit period and jumping in. It evaluates a lot of data that makes it hard for the do-it-yourself type like me to emulate.
Here’s a bit of what I’ve seen from him:
- Historical trend analysis/probability analysis, average monthly price compared to current price.
- Average monthly performance throughout the lifetime of the stock.
- Share performance versus the S&P/beta analysis.
- Volume indicators and MACD.
- Basic fundamental analysis, such as quarters that are the strongest in terms of revenue, times of the year the company generally makes big announcements, etc.
Those factors help determine the optimal time (for maximum profit potential and minimal risk) to enter a particular trade.
This strategy is at its best with small- and mid-cap stocks because it takes advantage of companies that can’t diversify their income streams smoothly over the year; therefore, there’s less reward for long-term holders.
Although I’m not dumping my core holdings in favor of a Prime-Period Portfolio, having some positions in stocks that seasonally outperform is a nice diversifier for my trading portfolio. I am always looking for an edge.
P.S. The Pepperdine School of Business found that the strategy used in the Prime System Joe mentions would have historically generated returns five times greater than a buy-and-hold strategy, all while reducing risk by more than half. If you are interested in learning more about the system... click here.