This study aims to investigate whether seasonality in the Kuala Lumpur Stock Exchange (KLSE) still exists after the Asian financial crisis of 1997/1998. In particular, the Chinese New Year (CNY) effect, also known as the February effect, will be examined. Past studies have put forward this calendar anomaly in the Malaysian stock market, which states that stock market tends to rally and rise in periods surrounding the CNY festival. Yet, most of these studies are concentrated during periods before the Asian financial crisis of 1997/1998 (Neoh, 1986; Ho, 1990; Wong et al. 1992; and Zamri and Simon, 2001).

The contents of this chapter would consists of a brief introduction of KLSE and some pertinent information regarding the Malaysian stock market, an overview of the CNY festival, a description of the Efficient Market Hypothesis (EMH) theory, a foreword to seasonality issues in the stock markets (calendar anomalies), the CNY effect in stock markets, followed by the objective and contribution of this study.

The KLSE is an exchange holding company that was established in 1973 and subsequently listed in 2005. Due to demutualization exercise for the purpose of boosting its competitive position and being more responsive to global trends, KLSE changed its name to Bursa Malaysia Berhad on April 14, 2004. Today, KLSE is recognised as one of the largest bourses in Asia with just under 1,000 listed companies offering a wide range of investment choices to the world.

There are two main markets under the securities market, namely the Main market and Access, Certainty, and Efficiency (ACE) market. The restructuring of the listing and equity framework is to facilitate efficient access to capital and investments, in addition to making KLSE a more competitive platform globally. The regulatory processes have also been streamlined accordingly to allow for greater certainty, minimize time-to-market activities, and reduce regulatory costs. As at 31 December 2009, there are 844 companies listed under the Main market, 116 companies listed under the Access, Certainty, and Efficiency (ACE) market, and its total market capitalization stood at RM 999 billion (Bursa Malaysia Annual Report, 2009).

CNY festival is considered as one of the most important festival of the traditional Chinese population. It is celebrated by more than one quarter of the world’s population. This festival is mainly celebrated in countries where a considerable amount of Chinese population is present such as China, Taiwan, Hong Kong, Singapore, Macau, and Malaysia. It is also observed as a public holiday in other countries such as Indonesia, Brunei, Laos, Vietnam, and even South Korea. In Malaysia, it is a public holiday on the first two days of CNY festival.

There are many customs and rituals associated with CNY, and it can be seen as bizarre or peculiar in the eyes of those who do not celebrate this festival. Due to the belief that cleaning sweeps and get rids of all bad lucks associated with the previous year, family members of the Chinese community typically give their home a thorough cleaning on days or weeks prior to the festival. The colour red is prevalent, from house decorations to individual clothing.

Although the festival goes on for 15 days, visits to relatives and friends are discouraged and businesses should remain closed on the third day of CNY. Otherwise, misfortune may occur on the family members. In addition, no home should be allowed to sweep and mop the floor on the first day of CNY as it is perceived to sweep away one’s good fortune. No individual should wash their hair with shampoo on the first day as well for the same reason.

The first day of the lunar calendar year (Chinese calendar) signifies the beginning of the festival and ends on the fifteenth day. On the eve of CNY, family members from far and near will get together for a reunion dinner. As with other festivals in Malaysia, CNY celebrations are symbolised by visits to kin, relatives and friends with the giving of “ang pow” (red packets), much to the delight of the younger generations. The CNY is synonymous with other practices such as lion dance, playing mahjong, and burning fire crackers, though fire crackers has been banned in this country.

The first day is for the welcoming of the deities of the heaven and earth. The second day of CNY is for married daughters to visit their birth parents. The ninth day of the New Year is a day for Chinese to offer prayers to the Jade Emperor of Heaven. This day is especially important for the Hokkiens. On the last day of CNY (15th day), commonly known as “Chap Goh Meh” or Chinese Valentine’s Day, is usually celebrated by throwing mandarin oranges into the river by single and unmarried ladies. It is believed that this practice would bestow them with a good husband in the future.

One of the most well-known documentations of EMH was provided by Fama (1970). Three forms of efficiency were proposed by Fama (1970), namely the weak, semi-strong, and strong form. Generally, the EMH asserts that security prices adjust rapidly and fully reflect all arrival of new information in the market. Therefore, in an efficient market, all opportunities of earning abnormal profits will be eliminated. Ever since the EMH was introduced in the 1970’s, a vast body of literature has been conducted to test the validity of this issue.

Several reasons that explain why market efficiency should exist were provided by Dawson (1984). First, the barriers to entry into the stock markets are low; the market consists of many buyers and sellers; and transaction costs are decreasing. Second, there is an existence of empirically strong support for the validity of EMH. Dawson (1984) also mentioned that markets do learn from experience, and this will eventually lead market efficiency to strengthen over time instead of disappearing.

EMH implies that earning abnormal profits by predicting movements of security prices is not feasible. Efficiency in the market should lead investors to believe that security prices do reflect its true value at all times. In financial markets, investors aim to uncover undervalued securities that deviate from its intrinsic value. Identification of an undervalued asset may enable an investor to outperform the market by realizing higher returns.

However, EMH would rule out any possibility of using technical analysis (incorporating past prices to predict future prices) or fundamental analysis (identifying “undervalued” stocks) to earn abnormal profits. This also infers that an active investor may not outperform a passive investor with a buy-and-hold strategy. Furthermore, as competition between investors to identify “undervalued” stocks increases, the chances of exploiting the opportunity decreases and may eventually be eliminated.

Financial markets provide a platform for the optimal allocation of investment capitals. If EMH holds true, this suggests that security prices do provide a correct and accurate indication for making investment decisions. This is beneficial in that all market participants will be able to achieve a normal return. In addition, lenders in the stock markets will be able to use the cue in prices to construct efficient portfolios while borrowers can formulate strategies to take on efficient investment decisions that maximize their wealth (Annuar and Shamsher, 1993).

Ever since the EMH was proposed, a considerable amount of attention was dedicated to further investigate issues relating to the efficiency of capital markets. Surprisingly, all kinds of seasonality effects or calendar anomalies have been uncovered and documented in both developed and developing economies. Various seasonal anomalies such as month-of-the effect, day-of-the-week effect, holiday effect, turn-of-the month effect, and even cultural effect have been put forward (Cross, 1973; Dyl, 1977; Agrawal and Tandon, 1994; Brown et. al. 2002; Syed and Perry, 2004; Coakley et al. 2008; and Khokan and Abu, 2009).

In actual fact, evidences and substantiation opposing the widely accepted EMH theory have diverted much attention towards ascertaining the existence of seasonal anomalies in the stock markets. To date, some of the most common seasonality effects that have been established are January effect (Annuar and Shamsher, 1987; and Hansen and Lunde, 2003), day-of-the week effect (Syed and Perry 2004; and Gao and King, 2005), and cultural effect such as CNY effect (Wong et al. 1990; Cadsby and Ratner 1992; Chan et al. 1996).

Calendar anomalies are viewed as an opponent of efficient capital markets that present great challenges to the establishment of EMH. Seasonality or calendar anomalies represent irregularities and inconsistencies in stock prices, whereby stock prices tend to appreciate or depreciate at certain periods of the year. Average returns of stocks are different across different periods in a year. This observation clearly violates the traditional assumption of market efficiency. Calendar anomalies suggest that investors can acquire valuable information in regard to their investment choices. By observing patterns in the stock markets, investors may be able to earn abnormal profits by accurately timing their investment strategies.

In developed countries such as the U.S. and United Kingdom, the January effect has been addressed quite substantially. This monthly effect states that average returns in January are higher than other months of the year. Additionally, it has been widely argued that investors sell off poorly performing stocks in December to reduce their taxes as December is the tax year end. Subsequently, investors buy back the stocks in January that leads to the rising of stock market performance. This explanation is commonly referred to as the “tax-loss” hypothesis.

January effect has also been established in Malaysia. However, the “tax-loss” hypothesis is not applicable for such seasonality in the Malaysian stock markets. This is due to the differences in tax systems in Malaysia and other countries that support the “tax-loss” hypothesis. The day-of-the-week effect is another seasonality issue that have generated widespread attention. This calendar anomaly may allow investors to purchase stocks on days which provide unusually low returns, and later sell these stocks during days which provide unusually high returns to realize greater profits.

Measurement errors (Keim and Stambaugh, 1984) and settlement procedures (Lakonishok and Levi, 1982) have been suggested as some possible explanations for the day-of-the-week effect. Keim and Stambaugh (1984) proposed that closing price on Fridays may be attributed to positive random errors whereas closing price on Mondays may be attributed to negative random errors. In U.S. the authors reveal a likelihood of random type of measurements errors. Lakonishok and Levi (1982) mentioned that due to procedures of settlement stocks in the U.S. this should lead to higher equilibrium rate of returns on Friday and lower equilibrium rate of returns on Monday.

Holiday effect is yet another seasonal anomaly in stock markets, whereby it is quite substantially being confirmed in many countries. This holiday effect is seen by some researchers as having close relationship with cultural festivals like Muslim Ramadan or CNY with a prolonged holiday period. Generally, it is shown that stock returns on trading day before holidays have consistently generate high returns. Some of the earliest studies on holiday effects are provided by Merrill (1966) and Zweig (1986).

In fact, investor psychology is one of the most well-known explanations for the holiday effect (Brockman and Michayluk 1998). This explanation asserts that because of the “high spirit” and “holiday euphoria” surrounding pre-holiday period, investors have a tendency to purchase shares right before holidays. However, George and Andrew (2009) points out that to prove this hypothesis directly remains an uphill task.

As can be seen, the existence of seasonal patterns in the stock markets can allow market participants to earn high and abnormal profits, as opposed to EMH which rejects any trends or seasonal patterns in the stock markets. The issue of seasonality or calendar anomalies in the stock markets was first documented more than two decades ago; however, it still remains as an area of interests for many researchers today.

CNY effect is the notion that stock market tends to rally and exhibit greater performance in periods surrounding the CNY festival. Average returns during CNY period tends to outperform the average returns at other times of the year. In both developed and developing countries, evidences of CNY effect have been documented. However, most of these studies are concentrated towards the Asian countries. This may be due to the fact that the CNY festival is more profound and significant in these Asian countries compared to the Western countries.

Countries that have exhibited the CNY effect include China, Taiwan, Hong Kong, Japan, and Singapore, Thailand and South Korea. These studies were conducted mostly during the period of 1990’s. In most of these countries, CNY festival represents one of the major celebrations for the country’s citizens. Additionally, some of these countries are made up of a considerable amount of the Chinese population. As such, some researchers have linked the CNY effect to the “cultural effect”, at least in these Asian countries. This “cultural effect” implies that investors may be able to time their investments to earn superior returns during CNY.

In Malaysia, the examination on calendar anomaly of CNY effect has also been carried out by a few researchers, mainly concentrated during the 1990’s period. These studies have managed to provide us with a better perspective of the occurrence of this seasonal pattern in this country. The January and February effect that has been uncovered in the Malaysian stock market are perceived by some researchers as the CNY effect. The main argument is that CNY festival usually falls within these two months, and that the “tax loss” hypothesis that explains the January effect in other countries is not valid in Malaysia.

The focus of this study is on periods after the Asian financial crisis which took place in 1997/1998. In actual fact, evidences and documentations regarding seasonality in the Malaysian stock market especially after the Asian financial crisis is relatively faint or non-existent. One possibility is that there may be no researchers that have use these periods in an attempt to test the issue of seasonality/calendar anomaly in Malaysia.

Calendar anomalies like CNY effect have been established in this country before, however, past studies have mainly focused on the period between 1980’s and 1990’s (Neoh, 1986; Ho, 1990; and Wong et al. 1992), which is before the Asian financial crisis. Although CNY effects are quite well established in Malaysia prior to the financial crisis, behaviour and trends in the Malaysian stock market may have changed since the occurrence of the financial crisis. Hence, by using periods after the financial crisis, it may possibly uncover new evidences, facts or trends relating to seasonal issues in the KLSE market.

This study also looks into 10 other individual sectors apart from the overall KLSE market. Generally, calendar anomalies in Malaysia have been conducted by using only the KLCI index, which tracks the market performance as a whole. By providing a further examination on these individual sectors, it provides an opportunity to pinpoint specific sectors that exhibit the CNY effect and those that do not. For example, if the overall KLCI index does reveal signs of CNY effect, it does not necessarily indicate that all sectors in the market will experience the same movement. At the extreme, certain sectors may even act in the opposite direction from the movements of the overall market.

As such, it would definitely prove to be more useful and relevant to participants in the financial market when making investment decisions. By examining further into specific sectors, it may also serve as a stepping stone for investors to reap abnormal returns from this seasonal effect (if any) because they would know exactly which sectors to invest in. This will be able to assist investors in making more timely decisions in order to achieve the highest return possible while minimizing the risk of suffering losses.