Morgan Stanley unveils a detailed strategy that has worked perfectly for 3 decades for trading one of the world's largest markets around US holidays
- Fixed-income strategists observed some interesting price action just before Thanksgiving last year - Treasurys were rallying even though yields were broadly headed higher.
- They then studied futures around every holiday that the bond market is closed, and compiled the best long and short strategies that worked every year since 1987.
- This strategy can be used to time one of the world's largest markets, or as a supplement to trading decisions motivated by other factors, they said.
Days before Thanksgiving last year, fixed-income strategists at Morgan Stanley noticed something intriguing.
Treasurys were rallying even though their yields, which typically move in the opposite direction, were broadly trending higher. Their theory was that traders who had bet against Treasurys were covering their so-called shorts ahead of the long weekend, as holding on to these shorts could be costly if there was a major market-moving event.
And so, observing this price action, they studied Treasury futures every Thanksgiving and around every major holiday.
"We thought there might be scope to combine observed seasonality around each holiday into a potentially uncorrelated, rules-based annual trading strategy," Tony Small and Matthew Hornbach said in a note on Tuesday. "Such a strategy could either act as a timing tool or a standalone supplement to discretionary trading."
The cliché but absolutely necessary caveat here is that past returns don't guarantee future results.
"While history seldom repeats itself, it may rhyme enough for this strategy to offer investors an idea about how to tactically trade around US holidays," Small and Hornbach said. "In addition, this study opens the door for further analysis around non-US holidays given price patterns may exist in overseas bond futures markets as well as other asset classes."
They studied all US holidays during which the bond market is fully closed, and most investors are away from their desks. These include Memorial Day, Independence Day, Labor Day, Thanksgiving, Christmas, and New Year's Day.
Using 10-year futures prices in the five business days before and after each holiday, they initiated and closed long and short strategies on each of those days and compared them to each other. For example, a long strategy opened five days before the holiday and closed three days after, to one opened four days before and closed a day after.
From this, they selected strategies with a winning-to-losing ratio of at least 60% of the time. All trades occurred at 3 p.m. ET or earlier if the market closed early. It assumed the same number of futures contracts for every holiday every year.
The strategy returned 2.22% annually on average, and its best year was 2008, at 7.33%. Between 1995 and 1996, the strategy lost money around six consecutive holidays, the longest streak ever.
Below is a breakdown of the trading rules:
The strategists acknowledged that market drivers changed over time, but nonetheless offered up some ideas on why these rules worked with some consistency.
For example, it has been best to short 10-year Treasury futures before Christmas. It also so happens that central banks, among the biggest buyers of Treasurys, tend to shut down their purchases before the year-end and resume early in January. Also, investors may be selling Treasurys to fulfill year-end liabilities. And as buying resumes in full force in January, the model shows it's been profitable to go long after New Year's Day.
It recommends buying after Memorial Day, and has returned 1% or more every time the holiday fell on May 28 or later. The strategists suggested that month-end rebalancing or reinvestments of large quarterly refunding coupons may working in the market's favor.
"Given the risk of data mining, investors should accept this analysis with some degree of caution," Small and Hornbach said. "There is no guarantee that historical seasonality and past price performance will continue in the future."