Does seasonal affective disorder (SAD) influence the financial markets?
Kamstra, Kramer and Levi (2003) – from the Federal Reserve Bank of Atlanta, the University of Toronto, Canada, and the University of British Columbia, Canada – examined returns from several large stock exchanges around the world at varying latitudes and on both northern and southern hemispheres. They found a Seasonal Affective Disorder (SAD) induced seasonal pattern in returns as depressed and risk-averse investors shunned risky assets in the fall and resumed their risky holdings in the winter, leading both to returns in the fall that were lower than average, and to returns following the longest night of the year that were higher than average.
Following up on this general finding Lo and Wu (2009), from the University of British Columbia, Canada, studied whether and to what extent stock analysts were affected by Seasonal Affective Disorder. They examined quarterly earnings forecasts from 1980 to 2006. Their data included over four million observations. They found that analysts were more pessimistic in the fall season, as indicated by their earnings forecasts as well as their forecast revisions. However, this difference, while statistically significant was relatively small in magnitude. Forecasts made in the fall were net positive for one quarter out – but net negative for two, three, and four quarters in the future.
Dolvin, Pyles, and Wu (2009) – from Butler University, Indianapolis, Indiana, the College of Charleston, South Carolina, and the State University of New York, Oneonta – extended this analysis. They examined the error in stock analyst annual earnings estimates relative to actual earnings from 1998 through 2004, specifically concentrating on the potential pessimistic bias that is associated with SAD.
Their results suggested that analysts were generally optimistic in their forecasts but significantly less so during fall and winter, low sunshine SAD months. They also found this pattern was most pronounced for analysts located in northern states, who should have been the ones most affected by the disorder. They concluded that while the effect of SAD appeared to be present, it seemed to overcome the, well-documented existing positive bent in earnings forecasts, thereby making estimates more accurate.
Trading strategy: Note that analysts, as well as investors generally, have a tendency to be less enthusiastic in the September and October, particularly in northern regions. This information, by itself, is insufficient for a specific trading strategy. However, an edge can be gained by looking at seasonal patterns of specific securities. This topic will be covered in a future Alpha Interface book.
