Quantitative Momentum

CHAPTER 7Momentum Investors Need to Know Their Seasons

“… planetary aspects and sunspot activity have significant power predicting anomalies' returns.”

—Robert Novy-Marx, Journal of Financial Economics¹

Seasonality, broadly defined in the context of stock market research, refers to the idea of building timing signals based on the calendar. Turn on any financial news outlet and there typically is a discussion about seasonality. One of the more popular concepts is, “Sell in May and Go Away,” which suggests that investors go to cash before June and get back in to the market in November. However, a 2014 Novy-Marx paper titled “Predicting Anomaly Performance with Politics, the Weather, Global Warming, Sunspots, and the Stars,”² highlights an important point: One needs to be skeptical of seasonality-type claims. Moreover, Cherry Zhang and Ben Jacobsen review over 300 years of UK stock market data and conclude that documented seasonality effects should be digested with a healthy dose of skepticism.³ That said, a recent paper by Matti Keloharju, Juhani Linnainmaa, and Peter Nyberg using the latest data and research techniques shows that stock market return seasonalities exist in almost every asset class, are remarkably persistent over time, and are extremely large.⁴ At a high level, seasonality makes sense: Institutional and behavioral incentives plausibly can drive supply and demand shocks that create robust seasonality effects. We consider the effects of window dressing and tax incentives ...