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Reader Dennis Page of Beverly Hills MI suggested that we test the Turn-of-the-Month Effect with some minimal training of the rigidly oscillating monkey in our blog entry of 6/8/06. We have therefore trained two monkeys, as follows:
Turn-of-the-Month (TOTM) Monkey buys the S&P 500 index at the close six trading days before the end of each month and sells at the close on the fifth trading day of each month.
Rest-of-the-Month (ROTM) Monkey sells when TOTM Monkey buys, and buys when TOTM Monkey sells.
Starting both monkeys with $100,000 on 12/21/89 and charging them $20 for each trading round-trip through 8/7/06 (paying no interest on cash balances), we find that:
The following chart shows the account balances for TOTM Monkey and ROTM Monkey over the test period. TOTM Monkey wins convincingly, with just a few relatively short intervals when ROTM outperforms.
Over this period of 200 months, the S&P 500 index gains an average 0.7% around turns of the month and and average 0.0% during middles of the month. The standard deviation of returns around turns of the month is 2.8%, compared with 3.4% during middles of the month, so exploiting the difference in returns reliably is a long-term prospect.
In summary, S&P 500 index behavior over the past 16+ years indicates a fairly consistent and economically significant turn-of-the-month effect.
The Real Earnings Yield Model explains stock market behavior via two inputs, operating earnings and inflation rate, with the latter causing most of the short-term volatility. Might the risk embodied in mid-month Bureau of Labor Statistics releases of new U.S. inflation data systematically depress the price and increase the volatility of stocks in aggregate during the middles of months? In other words, do investors tend to reduce equity exposure around the time of inflation announcements?
Separately, a strategist at a European equity hedge fund reports that he, too, has tested the the Turn-of-the-Month Effect and found it to be simple and powerful -- "a killer!"
For related research, see Blog Synthesis: Calendar Effects and the Trading Calendar. See especially our blog entry of 7/20/06 on the Turn-of-the-Month Effect study.
