Sold in May and Went Away: Now It's Time to Buy

Includes: DIA, IWN, SPY
by: Timothy O'Rourke

While in my final year of graduate school at DePaul University I was part of a small group of students picked to manage a portion of the University’s endowment. We did quite well: A12.9% gain with an alpha of 49 basis points. We beat our benchmark, the Russell 2000 Value index (NYSEARCA:IWN), and had a higher rate of return than the endowment’s professional management team.

There were very few hard and fast rules we had to follow, except one: "Buy in on November 1st, and sell out the last trading day of April" - otherwise known as "sell in May and go away" - to students of behavioral finance.

After the volatility in the markets this week I decided to take a look at IWN, along with other major indices, to see how accurate "sell in May and go away" was in protecting investors this year.

The IWN, S&P 500, and Dow Jones Industrials all reached highs on April 29 and dropped substantially since then. The IWN was at $76.50; now it sits at $61.55. The Dow reached a high of 12,810; on Friday it hovered around 11,269. The S&P 500 was at 1363.00; it is now at 1178.61. What really astounded me was that all three indices had highs on April 29th and have not hit that high since!

If investors sold in May and went away they would have missed most major market corrections. A table on Wikipedia (here) shows that of all the stock market crashes/corrections, investors would have been protected from all but two minor crises if they had “sold in May and gone away”.

After accepting the "sell in May and go away" philosophy, there is one nagging question for each of us -- what do we do now, on August 14th (the time of writing)? You inevitably fall into one of two groups: You sold in May - or you didn’t.

If you have not cashed out your equities I would leave your portfolio unchanged and wait for the market to improve before you re-allocate. I do not think that the underlying fundamentals in the economy have changed significantly over the last couple of weeks or months. Risk of default on sovereign debt has increased, and fears gripping those investors in that debt have spilled over into the stock market. Once investors take a hard look at equities and see that the underlying fundamentals have not changed, the stock market will take back its recent losses.

If you did sell in May, it might be time to get back into equities. I am not sure where you put your money when you cashed out - municipal bonds, preferred stock, CDs, or just left it as cash - but the upside in equities after recent market declines promises a higher yield than most other investments. This upside potential in the stock market has nudged a record number of insiders to start buying in all sectors of the market. As reported on Barron’s two days ago, last week was the biggest week for insider buying since March of 2009. It should not go unnoticed that March of 2009 was the bottom of the bear market before the recent bull market run. The insiders are telling us, through thier purchases, that they believe the market will turn around. You can read the whole blog post at Barron’s here.

The second reason I am optimistic about a stock market recovery is that election season has officially started. The Iowa straw polls officially kicked of the election season last week. It has now become everyone’s best interest to put forth their best ideas to spur the economy, grow GDP, and pass legislation that promote job creation.

The “sell in May” philosophy in behavioral finance was well worth heeding this year, with major market indices shedding as much as 13.5% since April 29th. With the markets losing as much as they have, the time to buy has arrived. Inside buyers are buying stocks in record numbers, and it is time for us to buy as well.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.