'Sell in May and Go Away'....Really?

With the major indices near their respective 200 SMA lines after a big 3 month run up in the markets, it seems like a good time to cut and run. According to the old Wall Street adage, "sell in May and go away," one who invests in stocks during the colder months and then sits it out during the summer months has done quite nicely overall.

Throughout the history of the stock market, dating back over 100 years, stock gains in November through April have historically been stronger than May through October. The Stock Trader's Almanac has demonstrated this fact by tracking what would happen to a $10,000 investment in the 30 Dow stocks. Money invested in the Dow stocks in the "best six months" and then switched to fixed income in the "worst six months" over 56 years grew to $544,323. But money invested in the Dow in the "worst six" and then switched to fixed income in the "best six" compounded to a loss of $272. These results are startling, but it doesn’t mean that you will lose money if you don’t sell in May. All it means is that the chances are good that you will under perform the normal average market returns for all 12 months combined.

Why Does This Happen?

May itself is not really that bad historically; it’s the Memorial Day to Labor Day period that's the worst historically and that tends to give the whole six months a bum rap. The second quarter, which starts in April, tends to be weaker, as the effects of holiday bonuses and the holiday retail sales period fade out. By late May, tax refunds are over, so the flow of fresh funds into stocks slows down. Then it's summer, with people spending more time on the beach than at their trading desks or on the trading floor. Lower trading volume tends to limit stock gains and causes a more rangebound market. Volatility tends to lightens up as well.

By the time fall kicks in, the psychology has switched to a back-to-school, back-to-work mentality. In addition, big mutual funds are preparing for the end of their fiscal year in October. Historically, September is the worst month of the year for the Dow, NASDAQ and S&P and this falls in that six month range of the “sell in May and go away theory”.

Here is the Real Deal

So what are we supposed to glean from this information? Should you sell all your stocks now because it’s the beginning of May? Not so fast. We have to take a logical approach to this dilemma and really look into the numbers first. There certainly have been years where the market did well in the "bad" six month period. There is no doubt that this six month period has been historically a rather lackluster one.

However, history, as we all know, does not always repeat. After all, we are talking about averaging numbers from a 50 to 100 year period. Neither you or I are going to be in the stock market for that long a period, so this average number is irrelevant. If this happens to be a year when the market does well in the summer (and there have been years that it has), you will run the risk of missing out on some terrific gains if you sell.

Let's look at the numbers closer using the S&P 500 [SPX] instead of the Dow because that is a broader range of stocks. Here are the results if you sold your stocks on the first trading day in May and returned to the market on October 1st each year from 1969 to 2007 (Yahoo Finance provided data to 1969): 26 of the 38 years the markets had a positive return during those supposedly six historically bad months from May through September. There were only 12 years in which you would have successfully avoided a loss during that six month period.

Also interesting to point out is that during the grand bull market of the 80s and 90s, the average return during May through September was 3.68%. A positive return, albeit not overwhelming. The average return from 1969-1979 was -2.22%, and from 2000-2007 the return was -1.59%.

Outside of the big bull market of 1980-1999, this strategy would have worked. But the point is, it’s just averages. Year to year returns are very different and you don’t know which years will be good or bad. Over a long period of time, which is what these studies are based on, it is true that the market has underperformed in those months but it does not mean that you will lose money. And if you do lose some money, the statistics prove that it will only be a very small percentage.

The Bottom line

We just wanted to put these numbers into perspective before you jump the gun and sell because there is no doubt this “sell in May and go away” adage will be played out by the media. It’s all you are going to hear about for the next couple of weeks. But just look at the numbers and you’ll find that it’s not as bad as they make it out to be. The QQQQ and SPX should be held if you believe the market will rally into the election. Our strategy at StockTradersHQ will be as it always is. We will just look at the chart patterns and the technical indicators to make our buy and sell decisions. The seasonality factor is way overblown. Technical Analysis is not.

Disclosure: Author holds positions in the above-mentioned securities

Comments

[Pangaea]

Thanks. Here'a a related article on seasonality that reaches a different conclusion:

Stormy Summer Ahead
Jason Goepfert
May 06, 2008 1:45 pm
www.minyanville.com/articles/INDEX-Excha...