What is the “Halloween Effect”? To most people, it’s the extra pounds they see on the scale after eating too much Halloween candy.
In equities, the Halloween Effect has one similarity to the effect above – growth is involved. Along with your waistline, your returns on equity holdings start to grow after Halloween. Research dating back to the 1970’s shows that the months of November through April tend to have both better returns and lower volatility compared to the May through October period.
This corresponds well with several other observations and maxims. September is well known to be rough on stocks, giving the poorest historical returns of any month. “Sell in May and go away” is an adage that predates the Halloween Effect, but dovetails nicely with it. The “January Effect”, a typical increase in equity prices in January that is presumed to be the bounceback from December tax-related selloffs, also would play into the Halloween Effect.
The Halloween Effect was coined by Michael O’Higgins and John Dowd in 1990, and was studied extensively by Sven Bouman and Ben Jacobsen in 2002.
Bouman and Jacobsen analyzed stock market returns from 37 countries during the period January 1970-August 1998 and found the Halloween effect in 36 of the 37 countries (New Zealand was the only exception).
The effect was pronounced in many countries. The U.S. came in around the middle of the pack with an average return of 17.1% from November to April and 6.0% from May to October. Bouman and Jacobsen also found that risk was not a correlating factor.
In the appendix of the paper, Bouman and Jacobsen compared the Halloween effect to a buy-and-hold strategy (assuming that during the period of lower returns the money is invested in short-term Treasuries). For the 17 countries studied, 15 of them showed the Halloween Effect to beat the buy-and-hold strategy – including the U.S. However, the difference in the U.S. was not large (11.61% to 11.37%).
Follow-up studies by K. Stephen Haggard and H. Douglas Witte of Missouri State University tested the dependence of the Halloween Effect on the January Effect and the skewing based on extreme returns from outlying years, and found the model to hold up over the years 1954-2008 (the last years studied), but not before then. They also conclude that the Halloween effect can possibly beat a buy-and-hold strategy while accumulating fewer transaction costs.
However, neither these papers nor any others answer the question of why the Halloween effect works. Keep this in mind if you want to try your hand at exploiting it. There are outlying years that do not follow the trend, and you must always consider what is going on in the current environment and whether those events are likely to overrun the Halloween Effect.
For example, if you are going to sell your equities in the current market, where will you put your money that will provide a better return during the down times? The interest rate is so low right now that even a lesser stock cycle may provide a better return than Treasury issues. Would you go for precious metals? Will that shift fit into your long-term diversification plans?
Take into account all the factors, and proceed carefully anytime you want to time the market, even for longer-term timing events like the Halloween Effect. Otherwise, you may end up struggling to gain back the net worth that you lost from the Halloween Effect, while trying to lose ten pounds from the candy-related Halloween Effect.