Are Some Proven Investment Strategies Too Simple To Accept?

As goes January so goes the year. Avoid the first two years of the Four-Year Presidential Cycle. Buy in the fall of the 2nd year of the presidential cycle and hold through to the end of the third year. Sell in May and re-enter in October.

Those are all strategies proven to out-perform the market over the long-term. Don’t take my word for it. But also don’t blame the messenger. I am only reporting what hundreds of exhaustive academic and independent studies have clearly shown since forever.

However, as remarkable as the results of those strategies are, investors pretty much either ignore them, or blow them off as myths.

That evaluation is understandable by Wall Street’s brokerage firms and mutual funds, as well as money-management firms that advocate a buy and hold approach. They must do all they can to convince investors that the market cannot even be timed to the point of recognizing when risk is high and odds are to the downside. How on earth would they survive if their customers moved out of stocks and equity mutual funds to any degree, and the money went elsewhere for two years (in the case of the Four-Year Presidential Cycle), or for six months at a time (in the case of Sell in May)? Investors must be made to believe that it’s okay to buy any time, all the time, and let time take care of it.

Jeremy Grantham has some interesting thoughts on the subject. Grantham is the founder and CEO of GMO (formerly Grantham, Mayo, and Otterloo), which has grown from humble beginnings in 1977, to the international money-management firm it has become, with more than $117 billion under management for institutions and wealthy individuals. They must know something about markets.

Grantham has written often over the decades about his firm’s studies confirming the remarkable consistency and performance of the strategies and patterns noted at the top of this article.

In his recent quarterly letter to clients he writes of the Four-Year Presidential Cycle, “The results since 1964 of just holding from October 1 of the second year, and selling the following April, is that in 7 months you make almost all the returns of the 48-month cycle.” Yes, on average being invested the rest of the time adds little to long-term gains.

On another of the strategies, the third-year of the Presidential cycle is historically the most positive year in the cycle by far. Yet, regarding the Sell in May strategy, Grantham shows that from 1932 through 2013, even in the third year of the cycle, the average return from the previous October to April of the 3rd year, has been almost 20%, while from May to October the return on average was roughly only one percent.

On the ‘January rule’ (as goes the first five days of the month so goes the rest of the month, and as goes the month, so goes the rest of the year), he notes the tendency for January to most often be a positive month for the market. The catalyst seems to be that investors receive extra chunks of investable money around year-end, from tax-loss selling, year-end bonuses and the like. They look ahead at expectations for the year, and invest accordingly.

He notes that the January rule is quite consistent when both the first five days, and the month as a whole, are positive, forecasting that the market will be up for year.

However, he notes that it is even more consistent in the other direction, when the first five days, and the month as a whole, are negative. He says there have only been 14 such years since 1932. In all but one of those years the market ended down for the year. Even in the exception year, 1982, the S&P 500 was down 19% at it August low before recovering to close the year positive.

However, my interest is not that Grantham again confirms the importance of those patterns. I believe most investors are aware of them (except possibly those new to investing in the last five years or so).

Nor is my interest because 2014 is a year when all of those strategies are currently in negative mode; the Presidential Cycle, Sell in May, and the January rule.

What I found to be most interesting is what Grantham has to say about why investors and financial institutions ignore the proven patterns and strategies, or blow them off as unimportant.

I have always assumed it was because of the short-term ‘recency bias’ of investor thinking, and the fact that none of those strategies work every single year. It could always be pointed out that the Four-Year Presidential Cycle did not work last time around, or the January rule didn’t work three years ago, or Sell in May didn’t work last year. Admittedly, that seemed like odd reasoning, since no strategy, particularly buy and hold, works every year.

Grantham has a different explanation.

In his letter to clients, he notes that investors are very reluctant to take the strategies seriously, and admits to the same bias. He says that even though his firm’s research 35 years ago confirmed their performance, “They felt hokey and insubstantial 35 years ago, and another very good 35 years of performance has not changed that. Managers seem embarrassed to talk about these factors, and clients are reluctant to consider them. And this of course is the point: they carry career risk for professionals as being seen as trivial, and for clients just too simple to be true.”

Proven effective, but too simple! Yikes!

Of course this year the risk can be made to appear more complex by adding in valuation levels, the age of the bull, investor sentiment, heavy insider selling, and a dozen other factors that will no doubt get the credit if the market tanks, allowing the ‘patterns’ to be blown off again even if they follow their historic predictive value.

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Sy is president of StreetSmartReport.com and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.