Summer's Positive Gains Can Come With High Risks

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Includes: SPY, SSO
by: Dr. Duru

In 2008, I took an alternative look at the age-old adage to “sell in May” to better understand why May is such a feared month. Looking at the S&P 500 from Jan 1, 1962, to Dec 31, 2007, I concluded the following:

“I decided to look at May from a different perspective. I decided to compare lows and highs, the reason being that folks most remember high and low points and not average returns. It is the peaks and the troughs that carry the most emotional weight and persist in the memories of folktales…

... it is not typical for the market to top out in May for the year. When May is not the high for the year, traders get all summer long for repeated chances to bail for the year.”

I found that short-term traders who decide to hold through May, and then experience second thoughts, can get several opportunities to unload their positions at higher price points throughout the summer and beyond. Call this the benefit of volatility (supposedly absent from summer trading).

Now that May 2011 has closed down 1.4%, it seems like a good time to take yet another perspective on May’s legendary selling. This time I wondered whether May’s performance says anything about trading for the summer. I was quite surprised to discover that the summer tends to be a profitable time to trade, although it comes with high risks.

I used Yahoo Finance historical prices to get S&P 500 values back to 1950. I graphed three charts of performance:

  • The S&P 500 in May vs. the summer, June to August.
  • The S&P 500 in May vs. the summer enhanced with annual performance.
  • The S&P 500 in May since 1950.

Performance for May is calculated as the percentage change from the last trading day in April to the last trading day in May. Performance for the summer is calculated as the percentage change from the last trading day in May to the last trading day in August.

The chart of the S&P 500 in May vs. the summer, June to August, demonstrates the following:

  • The summer produces positive returns 60.7% of the time.
  • After May produces negative returns, the summer produces positive returns 54% of the time.
  • After May produces positive returns, the summer produces positive returns 66% of the time.

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The summer tends to produce positive returns on the S&P 500
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The summer tends to produce positive returns on the S&P 500.

So, summer tends to produce trading profits, pretty much no matter what happens in May. Traders who decide not to go to the Hamptons and other select beaches for the summer actually stand a good chance of making money going long. (Of course, in this electronic age, a trader can always stay within a smart phone’s distance of making a trade anyway).

I next transformed the above chart into a bubble chart where the width of the bubble represents the S&P 500′s performance over the entire year (from the last trading day of the previous year to the last trading day of the year of interest). Since the stock market has an upward bias over the longer-term, I wanted to get a sense as to whether the summer’s tendency for positive returns is simply coincident with the returns for the year. Sure enough, the chart below shows a clear dominance of positive annual performance coincident with positive summer performance. There is a near 50/50 split of annual performance coincident with negative summers. The white bubbles represent negative annual performance.

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Positive annual performance goes hand-in-hand with positive summers
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Positive annual performance goes hand-in-hand with positive summers.

I also wondered whether summer’s performance is a result of the strong up years before and after the stock market’s twin crashes. The chart below shows no such trend. In fact, while the median summer return since 1950 has been 1.6%, the past 21 years have been heavily skewed toward large down summers. No wonder traders these days tend to dread the summer. Note that 11 of these 21 years actually produced positive returns. The 1980s almost always brought good tidings.

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The pattern of summer performance has changed over the decadesClick to enlarge

The pattern of summer performance has changed over the decades.

If recent relationships hold, the lesson here is that betting on a positive summer this year is a good one given 2011 appears to be on track for a positive performance. However, if this assumption turns out the be wrong, it could be very wrong.

For more “fun with numbers” see my last analysis of the post Labor Day trade and trading at the beginning of the year.

Be careful out there!

Disclosure: Long SSO puts. I am short SSO.