Solar Cycles and the Stock Market (21 January 2013)

The current solar cycle #24 is expected to peak in 2013, so should stock market investors prepare for this events? The previous solar cycle peaked in March 2000, and that was of course a major stock market peak. Will history repeat?

In this article we take a good look into that question, and we compare the solar cycle to the 10 year cycle (decadal cycle) so we can figure out which is the dominant cycle to watch. For this purpose we have used monthly data for the Dow Jones Industrials Index. These data go back to 1790 and are the longest series of stock market data we could find. Solar cycle data are easily found on wikipedia: http://en.wikipedia.org/wiki/List_of_solar_cycles (Note: because the 1930s (SC16) are too much of a statistical outlier, they have been excluded from the research. Including them could skew the numbers too much, which would defeat the purpose)

In search for solar cycle effects With solar cycle data going back to 1755 we can see how the Dow Jones Industrials (DJIA) has performed in each of the solar cycles since SC5 (solar cycle 5).

This chart shows the movements of the DJIA through all these cycles:

The solar cycles have varied from 9.5 years to over 12 years long. Some observations we can make here: 1) There isn't any consistent pattern that stands out from this chart. The stock market seems to have moved in all directions, regardless of where we were in the solar cycle. We just see a long term upward bias, which stems from long term economic growth + inflation. 2) The solar cycle peak, which typically comes after 4 years into the cycle, does not stand out from the chart either. In some solar cycles it was a market peak, in others it was a bottom. This means there is no reason to assume that 2013 will bring some kind of repeat of the March 2000 stock market peak.

Calculating the average DJIA performance over all these solar cycles, we get this chart:

There isn't much variation away from the long term average. This means that information based on where we are in the solar cycle, is of little or no use to decide when to buy or sell stocks. That is of course consistent with what we saw in the previous chart.

We also looked into the monthly volatility. Maybe stocks become more volatile around the solar maximum. This chart shows the average monthly DJIA volatility at various stages in the solar cycle:

Most of the time volatility is just crossing above and below the average, which is 3.3% change per month. Other than a tendency to have somewhat elevated volatility 1 to 2 years after the solar minimum, it seems to be just random noise. The solar max peak, 4 years into the cycle, does not stand out from the chart.

All in all, it doesn't look like considering the solar cycle is going to be of much use for timing long term moves in the stock market, at least not for the Dow Jones Industrials Index.

A look into the 10 year cycle Another candidate when it comes to long term cycles in the stock market is the 10 year cycle (decadal cycle), a well known pattern among long term investors.. So I have used the same long term DJIA data to plot out all of the decades since 1790:

At first sight this doesn't look very different from the solar cycles chart, but there is an important difference. Most of the decades show a significant decline somewhere between the middle of year 6 and the middle of year 8. You can see that in all but one decade the market was above 1 (above breakeven for the decade) by the middle of year 6. But by the beginning of year 8 we see that several curves have dipped below 1 again, only to recover in the last year of the decade. Even in those decades that produced powerful bull markets we see this typical setback in the 6 to 8 years.

Calculating the average performance over a decade, we get this:

Historically, there is an average 40% rise between the 3 year and the start of 6 year. Indeed, if you go back to the chart showing all decades you will see that nearly all curves are rising between year 3 and year 6. There is also an average 10% drop into the beginning of the 8 year. This reflects the drop we saw in most curves between the 6 year and 8 year. While we cannot expect that this pattern will recur every decade, it has happened frequently enough to deserve investor's attention.

The DJIA monthly volatility based on the 10 year cycle is also worth a closer look:

Here the chart doesn't hover around its average all the time. We see a long period of low volatility in the early years of a decade, with a bottom being reached early in the 3 year. Volatility then becomes low again in the 6 year, just before it goes up as the market typically corrects in the 7 year. Note: 2013 is obviously a “3 year” and last week the VIX index reached a multi-year low. So, this is perfectly in line with the long term average of the last two centuries, where volatility has typically become very low in early 3 year.

Conclusion Based on historic data for the Dow Jones index going back to 1790, the 10 year cycle has been more relevant than the solar cycle. Both from the perspective of market performance and of market volatility, the solar cycle doesn't show any reliable patterns for an investor to exploit. The 10 year cycle is clearly superior in that regard. This is probably just a psychological effect, but that doesn't invalidate it. This doesn't mean the solar cycle is completely useless. For example, some connection between the solar cycle and climate has been found, and as such we would reasonably expect it to have some effect on certain sectors like: agriculture (droughts or freezing of crops...), tourism , insurance (weather related disasters), energy (heating and airco),... The problem is we don't have sufficient reliable long term data for individual sectors. If we can only test a hypotheses over a few solar cycles or decades, then it becomes too unreliable. In fact, even with the Dow Jones data since 1790, we are only looking at about 20 cycles, which means that we have to be very careful with it. Based on just 20 cycles we cannot be too confident in the results. Just like tossing a coin 20 times, you might get heads 14 times. Time will tell whether these patterns continue to show up or not. It's good to know these longer cycles and you should keep an eye on them, but don't get married to them...

Good luck.

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