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Wondering about Wall Street’s mood? Look up

Research shows that the stock market goes up on sunny days and dips on gloomy ones.

FORGET about buying low and selling high. If you are worried about the recent volatility in the stock market, perhaps you should let the weather be your guide.

Buy cloudy. Sell sunny.

If you consistently bought stocks when the sky was grey and overcast and consistently sold stocks when the weather was bright and sunny, and you did this over a period of 16 years across 26 stock markets around the world, you would…well, let’s just say you would be lounging on a hot beach right now with a long, cool drink next to you.

Research into the psychological effect of weather on the stock market has a surprisingly long history, and no, this is not goofy theorising by armchair investors. Data reveal strong correlations between sunshine, and possibly other weather-related factors, and the performance of the stock market.

The data obviously do not suggest that stocks always rise in sunny weather or that they always fall when it is cloudy. But the data do suggest that, on average, markets tend to go down when the sky is grey and to go up on sunny days.

In one large study of 26 stock markets around the world between 1982 and 1997, researchers David Hirshleifer and Tyler Shumway showed that the annualised average return on perfectly sunny days was 25 per cent, while the annualised average return on overcast days was only 9 per cent.

The researchers examined how each market performed on every trading day during a 16-year-period and compared the returns with daily meteorological data on whether it was sunny or overcast in the cities where the stock markets were located.

Dr Hirshleifer, a financial economist at the University of California at Irvine, said he was initially sceptical that there was a connection between sunshine and stocks.

‘We feel it is hard to argue with the data,’ said Dr Hirshleifer, who published his study in the Journal of Finance. ‘The evidence is quite strong…The difference is large and statistically significant and indeed comes from cloud cover.’

Various researchers have unearthed other weather-related effects.

Stock markets generally tend to do better in the winter, for example, than in the summer.

Several theories have emerged to explain the findings, and some theories contradict others. One school of thought has attributed the better performance of stock markets in winter months to the willingness of people to take more risks when it is cold. Others have pointed to a more prosaic explanation: At least in Europe and North America, people tend to go on vacations during the summer.

Dr Mark J. Kamstra, a finance professor at York University in Toronto, argued that seasonal variations in the markets might be linked with a psychological condition known as seasonal affective disorder, which is linked to diminished amounts of sunlight starting in autumn.

Dr Kamstra based his argument on a study he conducted that looked at the number of daylight hours and stock market performance in countries located at different latitudes – where the amount of sunlight varies naturally.

People with seasonal affective disorder tend to become depressed as the days grow shorter.

Since people with depression are often risk-averse, he said, this might explain why markets do poorly in autumn. By November, however, nearly everyone who is going to get the disorder has got it (and presumably got out of the market), which is why Northern Hemisphere stock markets typically do better between December and February.

Professor Ben Jacobsen, a finance professor at Massey University in Auckland, New Zealand, argued against that explanation, saying his own analysis does not support the theory. Besides, he added, if investors were making mistakes because of a disorder linked to a lack of sunshine, they ‘would probably be fighting it now using sun beds’.

Dr Hirshleifer said his study of 26 stock markets found that sunshine was the only factor that mattered, even in countries that were warm and sunny all year round.

‘There is evidence that on sunny days, people give larger tips in restaurants, while suicides go up on cloudy days,’ he said. On bright and cheerful days, people also tend to give more optimistic answers about how long they expect to live and whether their marriages will be stable or end in divorce, he said.

Given the transaction costs of buying and selling stocks, Dr Hirshleifer said it is impractical to use sunshine as a stable investment strategy, although an investor who is planning to sell some stocks anyway might want to time the sale to a sunny day of the week instead of a cloudy day.

‘The main lesson for investors is something broader,’ said Dr Hirshleifer. ‘It is important to discount for your moods in making investment decisions.’

 

Source: Washington Post (The Sunday Times 9 Dec 07)

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