Weather and Equities: A connection?

After venting my thoughts on the state of India, the country, I return to the world of equities – and sanity - with this post.

Seasons come and go, years go by…but to suggest some connection between the weather and the equity market would sound somewhat ludicrous, won’t it? I had this strange hypothesis of Summer being the worst ‘season’ to trade Indian equities, and Winter the best. Did the actual numbers support this theory? Apart from the intellectual exercise, I wanted to see if a trading strategy could be built around the Indian seasons. Here’s the outcome of my curiosity...

In this post, I take a look at the performance of the BSE Sensex since its birth. A ‘filter’ here is that I have split up the months of the calendar year based on the ‘Indian Seasons’. So, I have June to September representing the Monsoon season, October to January representing Winter, and February to May representing Summer.

Summer Effect

There are some sound reasons for Summer being the worst season to trade equities. First, there is the much awaited yearly budget, which brings with it an air of uncertainty and volatility, both before and after the announcement. In the world of equities – and indeed investing – uncertainty implies that market players are reluctant to commit to one particular view on the market. Result…money is taken out of equities and people play a wait-n-watch game. End result: Gains are muted, or, in some cases, markets exhibit negative return tendencies.

Second, the Indian market generally follows the April-March financial year. Money managers whose bonuses are hinged on their portfolio values as at financial year end are most wary about a sudden downturn. Why should I let go of my hard-earned bonus to a suddenly fickle market? Result…they book profits and take money out of the market. End result: Again…gains are muted, or…well...

Third – and this is my hypothesis – summers are psychologically the worst for human beings. The heat tends to make people highly susceptible to the slightest of provocations. A couple of avoidable incidents on the way to office…and the mind is inclined to succumb to impulse decisions. Psychologically, human beings are wired to lose their heads when the requirement is just the opposite. So, one bad decision generally precipitates to another...

“A bad head…is often a sad head…” – Yours truly.

A combination of the above (and some more that I haven’t mentioned for want of space) made me believe that summers ought to be the worst season to trade Indian equities. (Was I correct? Wait a while…)

Conclusion: Go away in Summer.
Not-so-rainy-days

After the unwanted uncertainty in summer, the monsoon brings with it an inflow of new investments. Now that there is ‘certainty’ regarding market direction, market players find it comfortable to initiate or scale up their exposures in equities. End result: Markets rise.

Another not-so-subtle reason for the rise in the markets in monsoon can be traced to brokerage houses. The beginning of the new financial year sees brokerage houses publishing their expected EPS figure for the market index over the next couple of years. The expected EPS culminates in next year-end targets for the indices (which invariably is higher than prevailing levels). End result: Money flows in…and markets rise.

Conclusion: Good season to go Long in Indian Equities.
Cool Winter Probably the most significant development in the investing world over the past decade has been the mobility of capital. Money managers now have the entire globe as a playing field. The rise of the emerging markets –particularly India – has been a key driver of Indian equity markets. The high return is just too juicy for money managers to act blind and stay in the sidelines.

Global money managers generally follow the January-December year. With their variable pay linked to year end portfolio values, there is every incentive to inflate the values towards year end. What better way than to invest in emerging market equities? Portfolio rejigging happens at the beginning of the year and fresh allocations for emerging markets are set. Given the attractiveness of India as an investing destination, shouldn’t the Indian Winter be a good one for going or staying Long on India?

Conclusion: The best season to go, and stay, Long in Indian equities.
The Result Here’s the table...
Looking at the long-run numbers (1979-2007), clearly Monsoon is the best season and Winter is the worst (albeit marginally) in terms of average return.

But the more recent – and probably more relevant – 2000-2007 period tells an interesting story. The Winter season emerges as the best with the highest average return. And the higher return has come at a significantly lower standard deviation, indicating the strength of this season from a trading perspective. The Summer season – as expected – has delivered an average negative return over the period. The Monsoon has delivered a reasonable return, albeit at a very high standard deviation.

I have also added the number of Up Moves (defined as >0% return) and Down Moves (defined as <0%>The Winter season has witnessed greater number of Up Moves (19) and lower number of Down Moves (9) compared to the other two seasons. Most significantly, the Winter season has not had a down season since 1997-98. The other seasons, sadly, cannot boast of this!

Conclusion The above exercise – apart from massaging my ego – could form the basis of a trading strategy. Of course, there is no certainty of the trend continuing in the coming years, but (sorry to reiterate), markets have memories. Longer the time period, stronger is the memory (and inertia). Things continue the same way until some external force breaks the pattern! The trade is simple: Enter in Monsoon, increase ones position in Winter…and exit in Summer.
It would be naïve to discount fundamental factors at play in the markets. But this strategy, as with any technical trading strategy, will work only if the user sticks to the rules of the game. If the premise on which a trade was entered changes, its best to change ones opinion!