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First Day of the Month Effect
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As the stock market closes out the ugly month of September, a lot of people are looking ahead to the bullish tendency for the first day of the month.
First days have a bullish bias, and since 2003 the SP500 has closed higher 65.7% of the time on the first day of the month, versus only 54.8% when we look at all days. This week's chart reveals that if a person had been invested only on the first day of the month, he would have beaten buy and hold. The two plots are hypothetical equity curves based solely on the SP500 Index, and discounting dividends, interest, transaction costs, and other factors which would matter for real investing. The point in doing this is not to calculate real performance, but rather to demonstrate the phenomenon.
There are even some hedge funds who have built their trading strategies around just this sort of month-based "seasonality". But before you go and start trading based solely on this one factor, there is a really big caveat to understand. The bullish bias on first days of the month really only works when the stock market is in an uptrend. From August 2008 through March 2009, first days went through a string of 7 down closes out of those 8 months, including a whopper of a 8.9% drop on Dec. 1, 2008. So this is far from being a surefire strategy.
Interestingly, this bullish bias on first days is a relatively recent phenomenon in market history. From 1976-1992, the 53.6% of up closes on first days was statistically indistinguishable from the 52.2% of up closes on all days. Then starting in the 1990s, as automatic investments became more of a widely used practice, first days started seeing higher closes much more often, as those fund flows helped to push up prices more.
2011 has not been such a good year for this phenomenon. With 9 months gone by, only 4 of them have seen a higher close for the SP500 on the first day of the month. This is part of that same story of how first days have a bullish bias only during uptrends.
At the point when the market finally starts trending higher again overall, then we can start expecting first days to show that historic bullish bias once again. But it is not an expectation we can apply during corrective periods for the stock market.
Editor, The McClellan Market Report
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