CHAPEL HILL, N.C. (MarketWatch) — There’s good news, bullish investors, because the odds are in your favor for the rest of this week and all of next.

That’s according to the stock-market-timing model with the best long-term record monitored by the Hulbert Financial Digest (HFD): the so-called Seasonality Timing System created in the 1970s by Norman Fosback. Fosback, who at the time was president of the Institute for Econometric Research, currently edits an investment-advisory service called Fosback’s Fund Forecaster.

Despite the simplicity of Fosback’s model — it is entirely mechanical, based on nothing more than the calendar — it has beaten every other market-timing system that the HFD has tracked over 30 years. According to the HFD’s calculations, a portfolio that invested in the Wilshire 5000 on the minority of days deemed to be seasonally favorable, and which otherwise earned the 90-day Treasury bill rate, produced a 10.3% annualized gain in those three decades.

A buy-and-hold strategy over the same period would have gained slightly more — 11.2%, or 0.9 percentage point a year more. But that’s an unfair comparison, since Fosback’s model calls for being invested in the market less than half the time. And that difference is a small price to pay for cutting risk by that much.

Fosback’s model combines two separate seasonal patterns: strength around the turns of the month and before exchange holidays. The period beginning Tuesday of this week represents a confluence of both patterns, and at least one of them remains in force until the end of December’s first week.

Too good to be true?

Is there a catch?

There are a couple reasons to worry about the Seasonality Timing System’s ability to perform as well in the future as it has in the past.

One cause for concern is the system’s popularity, since more investors are aware of it today than 30 years ago. And, needless to say, a pattern tends to weaken, if not disappear altogether, when too many try to exploit it.

In fact, popularity may have already begun the process of killing the proverbial goose that lays the golden egg. As you can see from the accompanying chart above, the system’s performance in recent years has been less impressive than it was in the 1980s and 1990s.

To be sure, at least part of this recent mediocre performance was caused by artificially low T-bill rates, which have been suppressed by the Federal Reserve’s monetary stimulus policies. That’s because a big chunk of the system’s historical return derives from T-bill rates, since it is out of the market more than half the time. So it’s not surprising that, with recent years’ T-bill rates only a couple of basis points, it’s been a lot harder for the system to perform as well.

The efficient market’s discounting mechanism may have played a role too. Fosback argues that the large-cap sector of the market has become “increasingly efficient” over the past two decades, one consequence of which is that “anomalies such as seasonality patterns receded in significance.” Since large-cap stocks dominate market-cap-weighted indices such as the Wilshire 5000, this helps explain why the Seasonality Timing System in recent years hasn’t worked as well when trading the overall market.

Fosback recommends that traders wishing to exploit his system, therefore, focus on the micro-cap sector. One related trading vehicle is the iShares Russell Microcap ETF IWC, -4.48% , which is benchmarked to an index containing companies whose median market cap is only $211 million (according to Russell).

To put that tiny figure into context, consider that the largest company — Apple AAPL, +0.86% —has a market value of $683 billion, or more than 3,200 times larger.

Catch #2

Another “catch” isn’t a criticism of the Seasonality Timing System, per se, but an inherent feature of how track records get calculated: Long-term averages don’t translate into a guarantee in any given year. Consider, for example, the percentage of time the Dow has risen over the two days prior to Thanksgiving and the day after — the three-day period of seasonal strength that Fosback associates with Thanksgiving. Since 1896, when the Dow was created, a gain has occurred 62% of the time, which means the market has gone up five of every eight times, on average.

That’s impressive from a statistical point of view, since it’s about 10 percentage points higher than that of all other three-day periods over the past century. But it still means the stock market declines 38% of the time.

To get the statistical odds of success arrayed in your favor, you need to bet on the Seasonal Timing System over many years. By way of analogy, consider a card counter in blackjack: A good card counter can increase the odds of winning a single hand to perhaps 55%, from below 50% for a non-card-counter. That means that his odds of success when playing a single hand are hardly better than a coin flip. However, by playing a sufficient number of hands, the odds of coming out a winner become closer to 100%.

Something similar may apply to the Seasonality Timing System. Your odds of success in any given instance may be statistically significant, but still not high enough to justify throwing caution to the wind. That’s why followers of the Seasonality Timing System need to follow it with discipline and patience over many years.

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