'Sell In May' Fans Should Brace For 'Buy In July'

by: Dr. Duru


July historically delivers relatively (and surprisingly) strong performance for the S&P 500.

July has been particularly strong in recent years and trading so far suggests another gain for July this year.

July's historical performance demonstrates that old trading adages become overly simplistic when examined through context and data.

As I have warned on several occasions, the adage to "sell in May" and go away until the Fall is an over-simplified approach to trading around the summer months. It turns out that the adage is mainly based on the severity of summer downturns when they DO occur and NOT on the frequency of summer sell-offs. In fact, summers overall tend to deliver good opportunities to buy dips and to participate in tradeable rallies.

For the second year in a row, the S&P 500 (NYSEARCA:SPY) gained around 2% in May. This May's breakout to fresh all-time highs has continued into the summer. The second half of the year has started well with a 1.3% month-to-date gain in the first three days of July. If history is any guide, July will be the marquee month of the summer. It could even be top-ranked for the year.

Firstly, from 1950 to 2013, 36 of the 64 (56%) months of May delivered gains for the S&P 500. So, May is hardly a slam dunk month for selling. Of those 36 years featuring positive Mays, 23 of them (64%) also delivered gains for the month of July. With July off to a strong start, the odds are even higher for July to close with a gain. Of the years with positive Mays, 27 of them (75%) delivered gains on the first day of July. On 19 of those years with strong July starts (70%), the entire month of July delivered a positive gain.

In other words, this numbers game is yet another way of recognizing that the summer is NOT a time for traders to go to the beach and forget about the markets. Indeed an adage to "buy in July" seems more appropriate.

Even without positive gains in May, July historically has been a strong month. Here are the stats:

  • 36 of the last 64 years (56%) have delivered positive gains for July.
  • After a 5-year losing streak from 1998 to 2002, Julys have turned in positive gains 8 of the last 12 years (67%).
  • A whopping 46 of the last 64 years (72%) have delivered positive gains for the first trading day of July.

Even more interesting is how July fares against other months in the year.

While the average performance for June and August is essentially zero, July's average performance is a healthy 1.0% (again from 1950 to 2013). This is also better than May's average performance of 0.2%. July is still at the bottom of the pile for months with positive average gains. However, in the post-recession era, July has ranked among the top months three of the last five years (60%):

  • 2009: 7.4% return ranked third
  • 2010: 6.9% return ranked second
  • 2011: -2.1% return ranked tenth
  • 2012: 1.3% return ranked seventh
  • 2013: 4.9% return ranked second

July's overall average rank for monthly S&P 500 performance is a very respectable fifth place. For the chart below, I assigned a rank of 1 for the month with the best performance of the year and a 12 for the month with the worst performance of the year. For each month, I took an average of its ranking from 1951 to 2013 (1950 does not include a monthly performance given the exclusion of 1949 data):

July's average rank is a respectable 5th place, making it a standout in the dreaded May to October period

I also created a chart showing the distribution of July's rank among monthly performances of the year from 1951 to 2013. Notice the relatively STRONG skew toward rankings in the TOP THREE of monthly performances for the year. July scores a top 3 rank an amazing 40% of the time. This of course means that the last five years have been extremely good for July on a historical basis.

July heavily skews to a top 3 performance ranking for a given year

Source for all price data: Yahoo Finance

A hit tip goes to Nightly Business Report which motivated me to examine July's performance on a comprehensive basis. Portfolio repositioning was the most plausible explanation offered for July's stand-out performance. Such an explanation is particularly consistent with the unusually strong starts for trading in July. The idea is that big funds make major portfolio adjustments for the second half of the year in July. These moves would of course need to result in net overall buying; apparently they do.

Regardless of the explanation for July's performance, it seems that July is a time to buy. If the market finally corrects this month, buying the dip seems like the most appropriate response. Perhaps the most important lesson from this exercise is the reminder it provides that old trading adages cannot be used without proper context…and a review of the actual historical data. For example, this year may prove yet again that January's performance is a poor barometer for anticipating the S&P 500′s performance for the rest of the year.

(I have posted my dataset in a spreadsheet on my Google drive).

Be careful out there!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I could make a (short-term) bullish or bearish trade on the S&P 500 depending on whether conditions trigger my trading rules (described in my blog).