Shutterstock Enlarge Image The theory of a yearly rally from June through August is easily debunked when you review returns going all the way back to the 1800s. CHAPEL HILL, N.C. (MarketWatch) — As Memorial Day approaches each year, many advisers — like clockwork — begin referring to a so-called "summer rally."
Here's what to do if yours does so this week: Get rid of him.
That's because advisers' "summer rally" is entirely a figment of their imagination. If yours actually thinks one exists, who knows what else she is also claiming to see that is entirely fictional?
To be sure, the stock market will rally sometime this summer. But it rallies at some point during every season of the year. There is nothing exceptional about the summer in this regard.
/quotes/zigman/627449/realtime DJIA 16,511.86, +20.55, +0.12%
That, at least, is what I found when I fed into my PC's statistical software the Dow Jones Industrial Average's return from the end of May to its highest close at some point during June, July and August. Though no adviser I know precisely defines what he means by a "summer rally," this way of measuring it presumably comes close. It reflects the maximum gain an investor could achieve if he had the clairvoyance — or sheer luck — to get out of the market at what, in retrospect, is its highest value during the summer.
At first blush you might be impressed: On average since the Dow was created in the late 1800s, the Dow gained 5.27% from the end of May through its highest close over the following three months. That comes to an annualized equivalent of around 23%.
If the stock market enjoys even an average summer rally, the Dow will be trading at more than 17,300 sometime in the next three months.
There's less here than meets the eye, however: When measured this way, every month can boast a rally of similar magnitude.
Consider what I found when I calculated, for each of the other 11 months of the calendar, the potential for a similar three-month rally. Specifically, I measured the Dow's average gain from the end of each month to its highest close over the subsequent three months.
Those other months' average rally was 5.22%. That is statistically indistinguishable from the 5.27% that was the case historically for May.
Furthermore, the only reason May compares even this favorably to other months is because of what happened in 1932, during the depths of the Great Depression. In that year's summer, the Dow nearly doubled.
Without outlier years like that one, the summer rally loses even more statistical support. Since 1940, for example, the average Dow gain from the end of May to its highest close over the next three months is just 4.0%. Seven of the other 11 months of the calendar sport higher average "rallies" than that.
Here's one way to make this summer special: Resolve to use it as the season to subject any of your hunches — summer rally being just one of them — to rigorous statistical scrutiny. You'll find that almost all of them are worthless.
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