Kaeppel’s Sector Seasonality Strategy
Posted in Calendar Effects
January 7, 2010
A reader suggested looking at the strategy described in “Kaeppel’s Corner: Sector Seasonality” and updated in “Kaeppel’s Corner: Get Me Back, Clarence”. The steps of this calendar-based sector strategy are:
- Buy Fidelity Select Technology (FSPTX) at the October close.
- Switch from FSPTX to Fidelity Select Energy (FSENX) at the January close.
- Switch from FSENX to cash at the May close.
- Switch from cash to Fidelity Select Gold (FSAGX) at the August close.
- Switch from FSAGX to cash at the September close.
- Repeat by switching from cash to FSPTX at the October close.
Does this strategy materially and persistently outperform? Using monthly adjusted closing levels for FSPTX, FSENX, FSAGX, a short-term interest rate composite as the yield on cash and the Vanguard 500 Index Investor (VFINX) as an investable broad index benchmark over the period January 1987 through December 2009 (23 years), we find that:
The following chart compares the average monthly returns over the entire sample period for three alternatives: (1) buy and hold VFINX (VFINX); (2) Kaeppel’s Sector Seasonality strategy (Sector Seasonality); and, (3) a similar seasonal strategy using only VFINX (VFINX / Cash). Calculations assume that:
- The December 1986 close for the Fidelity Select funds is the same as the close the first trading day in January 1987 (the earliest data available).
- VFINX returns for January-March 1987 are the same as those for the S&P 500 Index (March 1987 is the earliest available data for VFINX).
- The return on cash for a month is one twelfth the prior month short-term interest rate composite close.
- Given the low frequency and nature of the trades, ignore trading frictions.
- Ignore the tax implications of trading.
The Sector Seasonality strategy generates a substantially higher average monthly return than the benchmark alternatives, but with a considerably higher variability in monthly returns. Applying the seasonality rules to the S&P 500 Index fund alone produces only marginally better results than buying and holding the index fund.
How do the parts contribute to the whole for the Sector Seasonality strategy?
The next chart shows the average return by calendar month for the Sector Seasonality strategy and for VFINX over the entire sample period. The Sector Strategy beats VFINX on average in 11 of 12 months. Four very strong years (1998, 1999, 2005 and 2007) drive the exceptional performance of the gold sector fund in September.
Is the average outperformance of the Sector Seasonality strategy consistent over the sample period?
The next two charts summarize average monthly returns for the three strategies defined above by subperiod (1987-1994, 1995-2002 and 2003-2009) and by calendar year.
The first chart shows that the Sector Seasonality strategy outperforms the other two strategies in all three subperiods, with outperformance most pronounced in the middle subperiod. The second chart shows that 1998 and 1999 drive the elevated outperformance of the middle subperiod (due to strong performances during those two years by the technology sector fund and the gold sector fund). The Sector Seasonality strategy beats buying and holding VFINX based on average monthly returns in 16 of 23 years (70%) and VFINX / Cash in 17 of 23 years (74%).
Is the outperformance of the Sector Seasonality strategy weakening overall?
The final chart plots the monthly performance of the Sector Seasonality strategy relative to that of VFINX over the entire sample period, with a best-fit linear trend line. The Sector Seasonality strategy beats VFINX in 154 of 276 months (56%). The trend line slopes slightly upward, suggesting that outperformance of the Sector Seasonality strategy relative to the broad market is not weakening. This persistence argues against both data snooping bias as an explanation of past performance and market adaptation after publication.
In summary, evidence from simple tests indicates that Kaeppel’s Sector Seasonality strategy may offer persistent average market outperformance (with some extra volatility).
