• Halloween indicator

    The Halloween indicator is a variant of the stock market adage “Sell in May and go away,” the belief that the period from November to April has significantly stronger growth on average than the other months. In such strategies, stocks are sold at the start of May and the proceeds held in cash; stocks are bought again in the autumn, typically around Halloween. This Halloween indicator is partially related to another well known effect: The January Effect.


    Though this seasonality is often mentioned informally, it has largely been ignored in academic circles (perhaps being assumed to be a mere superstition). Nonetheless analysis by Bouman and Jacobsen (2002) shows that the effect has indeed occurred in 36 out of 37 countries examined, and since the 17th century (1694) in the United Kingdom; it is strongest in Europe. According to the efficient-market hypothesis, this is impossible.


    It is not clear what causes the effect. Many supporters of the Halloween indicator suggest that people taking vacations and holidays during the summer months can lead to market weakness. There are exceptions: between April 30 and October 30 2009, the FTSE 100 gained 20% (from 4,189.59 to 5,044.55).  We can not say the Halloween Indicator existed in each and every year. But that’s hardly surprising, since no indicator works all the time. The question is, over progressively longer horizons, does the success rate grew to very impressive and consistent levels (should be much higher than 50%).


    Most interesting about the effect is that it shows that stock market returns in many countries during the period May-October are systematically negative or lower than the short-term interest rate, which also goes against the efficient-market hypothesis. Stock market returns should not be predictably lower than the short term interest rate (risk free rate).


    Popular media often refer to this market wisdom in the month of May, claiming that in the six months to come things will be different and the pattern will not show. However, as the effect has been strongly present in most developed markets (including the United States, Canada, Japan, the United Kingdom and most European countries) in the last decade – especially May-October 2009 – these claims are often proved wrong.


    One study which tests the Halloween indicator in US equity markets found similar results as Bouman and Jacobsen (2002) over the same time period but using futures data over the period April 1982- April 2003 and after excluding the years 1987 and 1998 no longer found a significant effect, leading these researchers to conclude that it was not an “exploitable anomaly’ during that time period in the United States.” Other regression models using the same data but controlling for extreme outliers have found the Halloween effect to still be significant. The original saying is “Sell in May and go away, stay away till St. Leger Day”, referring to the last race of the British horse racing season, however this day is unlikely to be known by non-Brits so it is replaced by Halloween (which in turn is Samhain, about one-eighth year after the equinox).

  • Mortgage myths

    Mortgage myths

    Following a good discussion on the topic of mortgage, I would like to share a few myths:

    The first year the payment is almost all interest. Your friends and your brokers keep telling you that the first year you will be paying a high portion of interest on your loan. What does that mean? Actually nothing! Many people interpret this in the wrong way. They don’t want to refinance again because the payments for the first few years contain higher percentage of interests. Once you passed the first few years, your payment include more principle and less interests. If you refinanced again, your payment will contain higher portion of interests again, thus disadvantage.  Their reason is that they are paying a lot of interest payments, so it seems a waste to refinance again because they think all the interest payments they made did not count anything.

    Well let me explain to you, there is no disadvantage for the first year. Why? The US government regulates the mortgage industry with clear disclosure, they can not cheat on you. If your APR is stated as 5%, then it is 5%. As long as you borrowed x amount money from your lender, you pay 5% on the x amount interests. You don’t pay more, you don’t pay less either, it is very fair. If you think you are paying a higher percent than this 5% for the first year, then you are wrong. It is against the law to charge more. So don’t explain to people that the first few years’ payments contain high interests, it does not help anyone, instead explain to people this: when you have x amount of borrowed money in your procession for one day, you need to pay interests on the x amount for that day based on APR, no more and no less.

    Mortgage interest is tax deductible thus there is a higher equivalent return. The question asked is this: if you have x amount of money, would you pay down the mortgage with y percent interest or would you invest in a mutual fund with z percent gain? A lot of people would answer the question saying that mortgage interest is tax deductible, making complicated mathematical formulas. It is true that because the mortgage tax is deductible, even you pay y percent interests to mortgage company, you would will get some money back from IRS at the tax time. Thus people believe that if they invest their money instead, they should target a tax equivalent gain much higher than the mortgage interests rate so that it is fair comparison. Below we will demonstrate the tax equivalent gain theory is wrong in this situation. If we ignore the situation that the capital gain may put you to a higher tax bracket, then we should only compare whether y is greater or smaller than z without considering the tax factor.  That is: if z is greater than y, then you should invest in the mutual fund even if you have to pay the capital gains  tax on it.

    Here is the math.

    option 1: pay down x amount to your mortgage. The result is zero: result=0.

    option 2: not pay down x amount at interest rate of y, invest the x amount to yield z percent.


    we explain each term below:

    -x*y  =this is the interests you pay. It is negative because it is going out of your pocket

    +x*y*T1=this is at the end of the year, you are getting the money from IRS. “T1” is ordinary income tax rate.

    +x*z=this is the investment yield

    -x*z*T2=this is the capital gain you have to pay IRS. T2 is either interests income or capital gain income tax rate.

    Thus if y=z, and if T1=T2, then the result =0. If T1>T2, then result > 0.  This means when the y=z, it is always better to invest your money.

    In summary:

    1. if you mortgage rate is y, don’t think about tax equivalent issue when you are making your decision.

    2. instead, simply compare the mortgage rate y with the investment gain z directly, if z is equal or greater than y, then don’t pay down your mortgage, invest the money to something else for z percent.



  • Money saving tips on home mortgage refinancing.

    The steady downward trend in mortgage interest rates in recent years have undoubtedly presented many opportunities to lock in historically low rates. With the downward trend anticipated to continue for the foreseeable near future, there are bound to be more opportunities to refinance into a lower interest rate loan. This article offers a lesser known tip on how to profit from every drop in interest rate.

    As any savvy borrower would know, refinancing into a like-kind mortgage product with lower interest rate can lower the monthly payment, but does not always translate into money saved over the lifetime of the new loan. The main reason is that the new loan will usually carry a longer term than the number of payments remaining on the original loan. This reset of payment schedule is what can drive the total cost for the new loan to be higher than the total payments remaining on the original loan!

    If the objective is to reduce the monthly expense, then by all means, refinance into the new loan. However do so knowing that the monthly savings come at the expense of higher total cost.

    If the monthly amount on the original loan is affordable, then there will always be money saved by refinancing into a lower interest rate loan and continue paying the same monthly amount as in the original loan. This strategy works if the new loan has no pre-payment penalties, no points, and no fees. By paying the same monthly as on the original loan, the additional amount is applied to the principle every month to effectively shorten the length of the new loan. There will always be money saved on this new loan when compared to the original loan. As an additional benefit, the new loan offers the option of paying the new lower monthly payment should the need ever arise. This would not be possible by staying with the original loan.

    In conclusion, whenever the interest rate drops, refinancing to take advantage of the lower rate is always recommended as long as the new loan does not impose pre-payment penalties and has no points and no fees. The only downside may be the hassle involved during the loan application process. Whether it is to satisfy a need to reduce monthly expense or to save money over the lifetime of the loan, the benefit of refinancing to a lower interest rate will outweigh every bit of hassle.

  • Presidential Cycle

    Presidential Cycle

    As we discussed in the marketing timing strategies, we will spend more time to dig deeper into the Presidential Cycle.

    The first year is the weakest of all four years. Higher returns during the last two years of a Presidential term than the first years. The expectation is that as a President takes office he begins to implement his proposals and investors, hunker down waiting to see the results. During the final two years the President becomes more concerned with his re-election and will ‘prime the pump’ in order to secure re-election.

    For generations, researchers have sought to make sense of the aggregated behavior. Is there any rhyme or reason behind anything that occurs in the markets or in life? The four-year U.S. presidential cycle is attributed to politics and its impact on America’s economic policies and market sentiment. Either or both of these factors could be the cause for the stock market’s statistically improved performance during most of the third and fourth years of a president’s four year term. The month-end seasonality cycle is attributed to the automatic purchases associated with retirement accounts.

    Mark Hulbert of MarketWatch compiled Dow Jones data dating back to 1896 and found the following:

    – the third year of a presidential cycle significantly outperforms all others, with average stock market gains of 15.5% compared to 8.8% in the first year, 0.4% in the second, and 4.1% in the fourth year.

    – the market performance in the third year of a presidential cycle is not statistically correlated to the market performance of the previous year; in other words, third years have tended to outperform other years regardless of whether the second year in the cycle experienced a boom or a bust

    – he also found that there is no significant correlation between stock valuations and market performances in the third year; “On average, third years perform just as well when price/earnings ratios are high as they do when those ratios are low”

    Marshall Nickles of Pepperdine University found similar results in his 2004 study.

    – historical stock market cycles dating back to 1942 have lasted an average of 4.02 years, which is essentially the same length as a presidential term; a cycle is defined as the time between peaks or the time it takes to go from a peak to a trough and then back to a peak

    – stock markets bottomed out only once during the third year of a presidential cycle in data dating back to the FDR administration. The one time the trough occurred in the third year was in December 1987 (Reagan). The average time frame for a market trough was 1.87 years into the presidential term. Markets never bottomed out in the fourth year.

    In general, incumbent politicians are more likely to be re-elected and their party remains in power if the economy has been doing well. Basically, satisfied voters have tended to re-elect incumbents. Politicians have tended to fiscal policy to buoy the economy during the campaign season.

  • January effect

    January effect

    As we discussed in the marketing timing strategies, January Effect is the oldest and more common accepted ideas. In this article, we expand the topic and look at more details.

    Increase in buying securities before the end of the year for a lower price, and selling them in January to generate profit from the price differences.  The “January effect” is that American stocks rise much more in January than in any other month of the year. It is called January effect but now the date may be moved earlier because people are buying the stocks earlier to profit from it. One theory explaining this phenomenon is that income tax-sensitive investors sell stocks for tax reasons at year end (such as to claim a capital loss) and reinvest after the first of the year. The second reason is the payment of year end bonuses in January. Some of this bonus money is used to purchase stocks, driving up prices. The third reason is that may people max out the retirement contribution at the end of a year and contribute to their retirement saving at the start of the year. The January effect may not be always true; for example, small stocks underperformed large stocks in January 1982, 1987, 1989 and 1990.


    Sidney Wachtel discovered the phenomenon in the 1940s, but it wasn’t until the 1970s that anybody took much notice. Many subsequent researchers have made many refinements and produced several ingenious explanations, usually suggesting that shares are dumped in December in response to tax or reporting requirements at year’s end. The January effect is a challenge to the efficient markets hypothesis. A reasonably bold version of that hypothesis is that you can’t beat the market without inside information. All publicly available information—including corporate accounts, price history, and what month of the year it is—is already taken into account in the market price. January Effect says “buy on Dec. 31 and sell on Jan. 31”, it just shouldn’t yield consistent returns.


    The history may indicate a very small, inconsistent inefficiency in the stock market. Exploiting a small efficiency may be all it needs for a professional trader. For average Joe, there are many other bigger mistakes he may make. Since January Effect is well known, there may be a very large number of investors making their bets based on the January Effect. Can small number of smart investors make money from mistakes made from a larger pool of average investors? It also won’t take long for all the obvious mistakes to disappear, because they’ve been so exploited. The date of January Effect would keep shifting until you are no longer sure there is such an effect.


    One closing thought, if I were to start a family of mutual fund or ETF, I certainly would have one for “no-January-effect Russell 2000” , another for  “January-effect Russell 2000”.