The turn of the month effect shows that historically all of the stock market’s gains come during just a few days each month. The rest of the time the market tends to tread water, or worse, on average. Hence, making sure your are invested at this time can help your returns if history is any guide. The rest of the time, sitting on the sidelines may even make sense
Definitions vary, but many argue that owning stocks from the last trading day of the month through the first three trading days of the next month captures the so-called ‘turn of the month’ effect.
Others argue for a slightly broader time window, of six days, or include the entire first half of the month. The reasons behind the effect are not well understood. However, one theory, sometimes termed liquidity-related trading, is that cash payments are often concentrated at month-end for many corporations, investment entities and retail investors. Hence at the turn of the month, money from these payments may then flow back into the stock market, boosting returns.
A Global Trend
The effect has been tested globally and appears to hold up in most countries. One study found the effect was less reliable in the Australian stock market, but did hold up in 19 out of 20 countries studied. The fact that the effect appears to hold up over geographies and over time is encouraging. Though like many of these stock market effects, decades of weak performance are not unheard of.
Has The Effect Faded?
Calendar effects should be easy to copy. Hence when these effects are broadly understood, the effect should disappear. A paper from the Atlanta Federal Reserve in 2000 found that the effect had all but disappeared in both the S&P 500 futures and spot market over the 1991-1999 period.
However, there is not necessarily a consensus that effect has gone. It may have just been a timing issue. Researchers at Robeco found that the effect still held over the 1963-2008 period in the U.S. market.
This finding is backed by research across Japan, Germany and the U.S. from 1991-2008 finding that the turn of the month effect does still exist. Though the two views that the effect has faded, and that it still works, are not necessarily inconsistent. It does seem that many calendar effects may have faded in the early 1990s only to return more recently.
If the effect does still exist, there are potential tax issues to consider. Holding for periods under a year in taxable accounts can push your capital gains up compared to longer-term holdings. That may make looking to trade on the effect counter-productive for some, or at least least tax-efficient than strategies like value investing that can set up far longer holding periods.
It does appear that the turn of the month effect is perhaps the strongest of calendar anomalies of the stock market. Still, it is puzzling why such a simple rule may boost returns well after its first discovery.
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