Last Updated on 10 February, 2024 by Trading System

The end-of-month effect is a recognized phenomenon in the stock market. But what you may not know is that the effect spills over to the first three days of the next month, which is why we termed it the turn of the month effect. This anomaly can be used to create a trading strategy.

In this post, we will explain why the turn of the month effect happens and show you the backtested results of the effect in several markets.

The rule of the strategy

The rule of the strategy is to go long at the close on the fifth last trading day of the month, and we exit after seven days (at the close of the third trading day of the next month). Exposure time is around 33%, but it performs very well in most markets and frequently beats the buy and hold strategy despite its low exposure time.

Why the turn of the month effect happens

The effect is most likely caused by some structural forces in the market emanating from an increased inflow of capital from savers or rebalancing from the fund management business. While we don’t know for sure why it happens, we know that it happens. We have tested the effect in the following sectors and markets:

1. The S&P 500
2. Emerging markets
3. Healthcare stocks
4. Retail stocks
5. Gold mining stocks
6. High yield funds
7. Real estate stocks
8. The gold market
9. Long term Treasury bonds
10. Consumer staples
11. Brazilian stocks
12. Japanese stocks
13. Bitcoin
14. Commodities
15. Utilities
16. Energy stocks
17. Nifty Fifty (Indian market)

The end of month/turn of the month seasonality in the S&P 500

The strategy has worked very well since at least 1960.

Here’s the result:

• CAGR: 7.2%
• Buy and hold CAGR: 7.1%
• Drawdown: -27%
• Buy and hold drawdown: -56%

Compare this with the flipside: buying at the close on the third trading day of the month and selling at the close on the fifth last trading day of the month.

Not good enough and with an account-blowing drawdown.

Now, let’s see how the strategy performs in some random markets and industry sectors:

The emerging markets

Here, we tested it on Fidelity’s emerging markets ETF (FEMKX). See the equity curve below:

The result is as follows:

• CAGR: 11.52%
• Buy and hold CAGR: 6.2%
• Drawdown: -34%
• Buy and hold drawdown: -72%

The healthcare sector index fund

This is how the strategy performed on the healthcare sector fund, HCPIX:

The results:

• CAGR: 10.1%
• Buy and hold CAGR: 7.9%
• Drawdown: -33%
• Buy and hold drawdown: -65%

The retail sector

The strategy was tested on FSRPX, and here’s the equity curve:

Here’s the result:

• CAGR: 12.2%
• Buy and hold CAGR: 9.6%
• Drawdown: -31%
• Buy and hold drawdown: -70%

The gold mining stocks

The strategy was tested on FSAGX. While gold mining stocks have had a poor long-term performance, the turn of the month strategy has been reasonably consistent for over three decades:

See the result:

• CAGR: 7%
• Buy and hold CAGR: 3.75%
• Drawdown: -54%
• Buy and hold drawdown: -79%

High yield funds

The strategy was tested on SPHIX, and it shows a pretty significant edge:

Here’s the result:

• CAGR: 8.8%
• Buy and hold: 7.4%
• Drawdown: -8%
• Buy and hold drawdown: -31%

Real estate sector

The strategy was tested on IYR. The equity chart below shows that it has beaten the buy and hold over the last twenty years:

The result:

• CAGR: 10.9%
• Buy and hold: 8.8%
• Drawdown: -22%
• Buy and hold drawdown: -74%

The gold market

The strategy was tested on GLD, and the result was not so good. One of the reasons could be that the gold price is “detached” from the stock market. See the equity curve:

Here’s the result:

• CAGR: 2.85%
• Buy and hold: 8.3%
• Drawdown: -33%
• Buy and hold drawdown: -45%

Long-term Treasury bonds

The strategy was tested on TLT, and the result was poor as expected because the bond market doesn’t usually correlate with the equity market. See the equity curve:

Here’s the result:

• CAGR: 0.3%
• Buy and hold: 6.5%
• Drawdown: -23%
• Buy and hold drawdown: -26%

The consumer staples sector

The strategy was tested on FDFAX, Fidelity’s consumer staples fund. Here’s the equity curve:

The result is as follows:

• CAGR: 8.5%
• Buy and hold: 7.6%
• Drawdown: -21%
• Buy and hold drawdown: -41%

The Brazilian stock market

The strategy was tested on EWZ of the Brazilian stock market, and it seems to yield abnormal returns. Here’s the equity curve:

The result:

• CAGR: 19.7%
• Buy and hold: 6.2%
• Drawdown: -43%
• Buy and hold drawdown: -77%

The Japanese stock market

Although the Japanese stock market has not performed well after the bubble burst in 1989, the turn of the month effect has performed quite well in that market and has beaten the buy and hold handily. See the equity curve for our test on EWJ:

The result:

• CAGR: 6%
• Buy and hold: 1.7%
• Drawdown: -25%
• Buy and hold drawdown: -59%

Bitcoin

Even in bitcoin, the turn of the month effect can be seen. See the equity curve below:

The result:

• CAGR: 51.3%
• Buy and hold: 94.2%
• Drawdown: -38%
• Buy and hold drawdown: -83%

The commodity market

While commodities have performed poorly over the last decades, they have performed better with the turn of the month strategy. The strategy was tested on DBC, and here’s the equity curve:

The result:

• CAGR: 5%
• Buy and hold: -1.8%
• Drawdown: -28%
• Buy and hold drawdown: -76%

The utility sector (FUGAX)

The strategy was tested on FUGAX. You can see the equity curve:

The result:

• CAGR: 7.6%
• Buy and hold: 6.7%
• Drawdown: -24%
• Buy and hold drawdown: -71%

The technology sector (FADTX)

It was tested on FADTX, and it seems the effect is more erratic compared to the S&P 500. Here’s the equity curve:

The result:

• CAGR: 8.6%
• Buy and hold: 9.5%
• Drawdown: -51%
• Buy and hold drawdown: -83%

The energy sector (FANAX)

The strategy was tested on FANAX, and even though the energy sector has been a poor performer over the last three decades, it performed quite well:

The result:

• CAGR: 9.9%
• Buy and hold: 2.2%
• Drawdown: -39%
• Buy and hold drawdown: -82%

The Indian Nifty Fifty

We end this post by looking at the Indian market; specifically, the Nifty Nifty (^NFTY). See how the strategy performed in the equity curve below:

The result:

• CAGR: 9.7%
• Buy and hold: 9.5%
• Drawdown: -34%
• Buy and hold drawdown: -60%

Will the turn of the month anomaly continue to happen?

Well, we don’t know for sure. But if this is a structural behavior of the markets, as we believe it is, it will likely continue. After all, it has consistently been seen in the S&P 500 for over 60 years, even before passive index funds came to life.

Read more similar articles here on The Robust Trader or on Quantified Strategies