Balancing the Hot Air

Most western homes are heated with forced air, and if you live in a two story, forced air home, it’s important to adjust the air registers twice a year. In the winter, close the upper story registers and open those on the bottom floor. Remember, hot air rises. In the summer, when the air conditioning is running, do just the reverse: close the lower level ducts and open those upstairs.

This process is called balancing the heating ventilation and air conditioning system.

In a similar manner, it’s important to balance the information we use when making decisions. We use the term “hot button” to describe items that essentially rise to the surface of our consciousness, oftentimes without just cause. Recently, I heard a respected economist declare that for the past four years “… all the stock market returns were generated during ‘earnings season’”.

The “earnings season” is usually considered to be the first month of each calendar quarter, or the months of January, April, July and October. It is the period of time when virtually all the public companies report their fortunes from the previous three months.

Thinking I’d heard about something really significant as a tool for timing trading activity, I did a little digging. If he was correct, one would expect to see significantly better returns during the four months of earnings season than during the other eight months.

You can see in the attached chart that the market has had positive returns during those other eight months nearly two thirds of the time. Additionally, every one of the “earnings season” months was negative at least one of the four years, meaning there was a 25% chance of a drop during earning season.

Looking at the past six decades, it’s a similar story. The returns during earnings season are indeed stronger than the other eight months. By my calculations, the average earnings season return is 1.11% versus 0.47% per month for the other eight months of the year. These numbers work up to an 8.23% average annual return and do not account for the dividends, consistently more than 2% per year, bringing the historic return on the stock market to better than 10%.

It turns out that the celebrated economist was using his own definition of “earnings season”, a definition not easily verified and thereby providing hot air to lift his own public profile.

More important than raw numbers, averages or history is what’s happening in the immediate future with investments in company stocks. What will propel companies to continue reporting strong or even record profits? How will we know if the market itself is filled with hot air?

We don’t know for sure what will happen in the future, but we do know where the biggest risks lay. It is most likely that for the foreseeable future, interest rates will continue to rise from their recent record low levels. The FED’s recently announced tapering program will allow that to happen, and I believe the tapering is way overdue.

A reduction in the stimulus is only going to happen when the economy is able to handle it. Currently, many indicators lead me to believe that the economy can stand on its own. We still have some pockets of serious problems; California’s high desert regions were particularly hard hit by the recession and continue struggling, but overall the economy seems to be expanding nicely.

According to Economy.com, fourth quarter GDP was up 1.1% from the previous quarter and 4.2% over 2012. Strong Consumer confidence led to an excellent Christmas sales season overall. Vehicle sales remain above average, and unemployment nationwide continues its steady improvement, down to 6.7%. Inflation? … Not a problem.

As always, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. You should talk with me about your particular situation and the investment mix that can help you work towards your long run goals[i].

i For purposes of defining the “market” or “stock market”, I’m using the S&P 500 index, an unmanaged index which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results. The data is sourced from Yahoo!Finance.

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