Explaining Summer Doldrums

In the December 2004 draft of their paper on “Gone Fishin’: Seasonality in Speculative Trading and Asset Prices” Harrison Hong and Jialin Yu examine the effect of vacation periods (summer in the U.S. and January-February in China) on speculative stocks during 1992-2003. They find that:

• Trading activity is lower during high-vacation periods (e.g. summer in the U.S.) than during the rest of the year. Summer trading declines by 12.5% overall, with a 7.2% decline for NYSE/AMEX and 14.5% for NASDAQ. Summer trading drops by 29% for dot-com stocks. An earlier sample (1961-1991) shows that summer trading drops more for small stocks (14%) than for large stocks (8%).
• Speculative trading puts upward pressure on asset prices. Prices of speculative stocks (such as dot-com and high-turnover stocks) are therefore weakest, as measured by valuation ratios, during vacation periods when trading activity is low. Specifically, the market-to-book ratio for U.S. dot-com stocks is nearly 42% lower in the summer than in the winter. Changes in liquidity (trading costs) do not explain this seasonality.
• Turnover (monthly trading volume divided by shares outstanding) of a stock is a measure of the divergence of opinion about the stock among investors.

In summary, this research suggests that investors should be inclined to sell speculative U.S. stocks in late spring and buy them in the fall.