Seasonality is coming to town! The weather is colder and the odds for snow are high, people are shopping for Christmas, and hearts are filled with joy and kindness. But when the time to measure the performance of financial markets comes, it seems that something is broken this year, as seasonality is not passing through. The historically bullish December has been turned into a highly volatile time bomb that has hijacked equities’ performance and smashed commodities.

Investor sentiment in the last quarter of the year and the first quarter of the next has been historically higher than for the rest of the year. A simple strategy consisting of buying equities at the end of October and selling them in the early days of May has always been thought by Wall Street as the wisest of the calls. Sell in May and go away, they say! And they’re right. This traditional saying is corroborated by academic research. Instead of a simple buy-and-hold strategy, an investor can improve performance buying at the end of October and selling at the earliest days of May. Bouman & Jacobsen in 2002 compared these two simple strategies and found that the Halloween strategy performs much better than the buy-and-hold strategy in almost all markets they analysed. For example, in the UK the mean returns from buy-and-hold delivered 14.9% per year between 1973 and 1996 while the Halloween optimisation would have boosted performance to 18.9%. Not only did such a strategy perform better but it also showed less risk across markets.

Historical data for the S&P 500 helps identify the best performing months. The chart bellow depicts the average monthly returns since 1950. As you can see, equity performance turns negative in May and remains negative until October (with the exception of July which is historically a good month). Performance turns positive in October and rises until the end of the year with December being the second best month of the year.

The S&P 500 index has returned an average of 1.66% during December. But, when looking at this year’s performance for the first half of the month, it seems very unlikely that seasonality will do something for investors, as markets have turned into negative territory and volatility is rising very quickly. The seasonal effect will likely not be enough to align prices with the 1.66% historical performance numbers, as there are too many negative developments in global markets that have been ignored for too long and are now playing out.

The usual seasonal vibrations did not extend to financial markets this year and global equities are down for the month. Last week was one of the worst weeks of the last few years not only for equities but also for oil. The S&P 500 declined 3.5%, the FTSE 100 lost 6.6% and oil prices were battered down more than 10%. Even though many equity indices are still positive YTD, there has been a clear erosion of sentiment. Unless there is an unexpected and sudden pick up in sentiment, we will see an odd December in terms of performance. Those who were predicting the Dow to close at 18,000 are now certainly thinking twice.

What’s happening?

While the year has started very well in terms of equity performance, the seeds for derailment were planted in December 2013 by Ben Bernanke. At the time, the chairman of the Fed set the basis for a later pick up in volatility when he confirmed QE was about to end in September 2014. At first investors did not expect the end of QE to compromise the US economy, as the data had been showing a significant improvement in economic conditions. The life-supporting blood coming from the central bank seemed no longer necessary and the US economy was on its way back to real growth. It did not matter how well the world economy was, as investors believed the US economy was insulated against foreign sluggishness.

But then came August and, in particular, September when the markets were hit by volatility. Eventually, the end of QE was just a coincidence, but the losses recorded made it clear that not everything was rosy. From record level to record level, the S&P 500 suddenly lost ground and dropped 10%. It was a free-fall decline, as if economic conditions changed dramatically. One day everything was fine, the next day everything was not. That was the first sign that the market was near a top.

The truth is that investors ignored the turbulence and order was restored for the traditional seasonality to play its role. The 10% loss was reverted before Halloween, and markets entered a new bullish trend that saw its end just a few days ago. After being used to an uptrend lasting for more than 5 years no one wants to lose upside potential. Investors saw the 10% decline as an excellent opportunity to buy again. They were right indeed! Equities fully recovered and extended gains to new record levels. But the mini crash showed just how vulnerable the current market is and how quickly gains can vanish.

More than anything, the small crash of September proved that the US economy is still heavily dependent on expansionary monetary policy and international economic developments. As soon as policy is reversed the market will lose ground, the extended growth in the dollar will negatively impact corporate earnings, and the lack of growth in Europe will erode growth in the US. These risks have been largely ignored.

The extra volatility that markets get rid of in October is here again. Last week the VIX index rose from 13 to 23, its largest weekly gain for the year, while markets were battered down. Investors have been largely ignoring the global weaknesses and managed to push the indices back to record levels. They also ignored the effects a 40% decline in oil prices YTD can have in the global economy. The decline in prices is partially the result of a war where Saudi Arabia is trying to keep market share while leading the fracking industry towards liquidation. But that isn’t the whole story, as demand has also been downgraded last week due to eroding growth prospects in Europe and in China in particular. In a global scenario where Russia is collapsing, Europe is not growing, Abe’s shock and awe is failing to derive the expected results, the oil industry is collapsing, and China is on a soft (or even hard) landing, it’s tough to see any reason for bullishness.

Investors are waiting for Mario Draghi to save the day early next year when he is expected to deliver the much-anticipated QE. But as far as I know, the US-style QE investors are expecting is seen as illegal under the ECB framework and strongly opposed by Germany. Before announcing more than TLTROs and covered bond purchases, there is still a long road to travel. I’m really not sure Draghi will be able to deliver what the market is currently discounting as very likely. If he can’t, then these prices will further correct down. But even if he can, I am not expecting much from it, as even Draghi already indirectly acknowledged that the ECB is just buying time for the necessary fiscal adjustments. At a time no one can find a good use for money, it does not matter how cheap credit is as no one will take it. That’s why the LTRO is failing.

Volatility is rising fast and the upside trend is now vulnerable. Unless there are some good surprises to come, the range of tricks still left available is so limited that not even the seasonal effects will save you.