In last week's piece, titled "The Power of Seasonal Trends", I wrote about, well, the power of seasonal trends. In that piece I described something I refer to as the "Known Trends Index", heretofore referred to the KTI for short. As detailed in my latest book, Seasonal Stock Market Trends, this index is comprised of 13 separate seasonal trends in the stock market - each of which can be tested back anywhere from 40 to 100+ years. The crux of the data presented was that low KTI readings have typically been accompanied by a bearish stock market and at each successively higher KTI reading, the performance of the stock market improves. At the low end the Dow Jones Industrial Average has lost ground at an annualized rate of -57%. At the high end the Dow has gained at an annualized rate of +37%.

Not surprisingly, a number of readers have mentioned that they are curious to know what the immediate future and the rest of 2009 looks like simply from a seasonal point of view. Before answering that question, a little perspective.

A Little Perspective

For my own purposes, I consider any KTI reading of +1 or lower to be bearish. I also consider any KTI reading of +5 or more to be bullish. Everything else is essentially ignored. For the record, the market has showed a fairly substantial gain during those times when the KTI stood at +3 or +4. However, these results have a lot more volatility associated with them, and for the record, the stock market got clobbered plenty last year while the KTI stood reading of +3 and +4 (the nerve!).

In any event, the key point is that I try to use seasonality to "gain an edge" in the markets, not as a "precision timing technique." So basically I focus on situations where the probability is highest (or lowest) that the market in question will likely move higher (or lower), rather than on situations where that market has shown a tendency to grind higher (or lower) over time.

The Past

Chart 1 displays the growth - or rather the decline of $1,000 invested in the stock market only when the KTI shows readings of -1, 0 or +1, respectively. To see what it looks like when you put them altogether see the chart in last week's article.

Chart 1 - Growth of $1,000 invested in Dow Industrials when KTI is at readings of -1, 0 or +1
Click here for larger view

Now, most people are not inclined to trade their entire stock or stock mutual fund portfolio in and out of the market on any regular basis. And this is perfectly understandable. Nevertheless, it can be argued based on the results shown in Chart 1 that there is simply not much point to being in the stock market when the KTI falls below +2.

Chart 2 displays the growth of $1,000 invested in the stock market only when the KTI shows readings of +2, +3 or +4, respectively.

Chart 2 - Growth of $1,000 invested in Dow Industrials when KTI stands at +2, +3 or +4

A close look at Chart 2 reveals that the market has typically worked higher when the KTI is between +2 and +4, however, there is also a fair amount of volatility and you can clearly see that the results were quite negative in 2008.

Chart 3 displays the growth of $1,000 invested in the stock market only when the KTI stand at +5 or higher.

Chart 3 - Growth of $1,000 invested in Dow Industrials when KTI stands at +5 or higher

As you can see in Chart 5, for the past 75 years a KTI reading of +5 or higher has been a strong indication of higher stock prices ahead.

The Future

So now we know what's happened in the past. But what about going forward? Looking at the stock market strictly from a seasonal standpoint, things don't look great through the end of 2009. Chart 4 displays the daily KTI reading through the end of the year. The only area of +5 readings occurs between June 30th and July 7th. The rest of the year is either "in the middle" (+2 or +3) or "at the low end" (at times in May, June, and September, October, November and December).

Chart 4 - KTI Readings through December 31st, 2009

Summary

So the obvious question is "since the KTI is signaling few bullish periods through the end of the year does that mean things get worse from here?" And the honest answer is "not necessarily." Like any market measurement tool, sometimes the KTI gets things right and sometimes it doesn't. The primary thing to take away at the moment is simply a note of caution. The recent stock market rally off of the March lows has buoyed the spirits of many individuals. And while we all want to believe that the worst is now behind us and that "the bottom" is in place, a glance at Chart 1 and the realization that there are more "unfavorable" seasonal periods between now and the end of the year than there are "favorable" seasonal periods suggests that one might be wise to remain cautious about buying into the bullish case.

As always, time will tell.

NOTES:

I will be teaching a session on Seasonal-based trading at this year's Optionetics OASIS, June 18-21. I look forward to seeing many of you there. For more information about this incredible event, please click here.

To learn more about Seasonal Stock Market Trend: The Definitive Guide to Calendar-Based Stock Market Investing, please click here.

To sign up for a free 1-month trial of Optionetics ETF Investor newsletter, edited by Jay Kaeppel and Clare White, you can do so by clicking here.


Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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