- Market returns have historically demonstrated strong seasonality, rising sharply from November to April and then producing modest returns between May and October.
- This article looks at a simple strategy that owns stocks from November to April and then owns Treasuries from May to November.
- While this strategy holds stocks half the time, it has strongly outperformed the S&P 500 with lower variability of returns.
In Tuesday's article, I took a deeper look at the old market adage of "Sell in May and Go Away." The article demonstrated that equity markets globally have experienced meaningful seasonality with equity returns from November to April far higher than between May and October. This phenomenon has held in developed and emerging economies globally over very long time periods, meaning this surprising, yet persistent, calendar effect has not been arbitraged.
As the calendar moves into early May, examining this market axiom seems prudent. My article Tuesday began with the disclaimer that for most investors, a buy-and-hold strategy that focuses on capturing long-run equity risk premium is preferable. During the current market correction, that long-term focus may be even more salient advice. Indeed, some investors noted that while semi-annual returns (tabled below) were weaker in the May-October period, they were still positive. Why turn our nose up at market gains?
For more trading-oriented portfolios looking to tactically reposition over shorter-time intervals, I decided to examine a strategy that held the S&P 500 (SPY) from November to April and was long duration U.S. Treasuries (NYSEARCA:SPTL) during the period from May through October. Using data dating to 1973, the longest data set I had for long Treasury returns, I found that this bi-annual switching strategy has generated structural alpha.
The results are fairly striking. This 1973-2019 time frame was a great period for U.S. stocks, which produced annualized returns of over 10% over the sample period. The seasonal U.S. equity/long Treasuries strategy did even better, producing a 13.6% annualized return. As one would expect for a strategy that owned Treasuries half of the time, the switching strategy also produced less variable returns.
The annualized return from the Sell in May and Buy Treasuries portfolio was 13.6% with a standard deviation of annualized returns of just 13.2%. The strategy beat the S&P 500, which it owned for half the time, by 3.1% per annum and did so with around three-quarters of the variability. The switching strategy was also far more likely to generate positive returns, which occurred in 42 of 47 years in the sample. These are gross returns that are assumed to be held in a tax deferred account or vehicle and are shown before the small transaction costs of a twice-a-year switching strategy.
While the S&P 500 produced a -37% return in 2008, the Sell in May and Buy Treasuries portfolio was just -8.7% in 2008. That switching strategy was in Treasuries during the Lehman bankruptcy and the market swoon in the fall of that year. The "Sell in May" strategy posted its worst year in the stagflationary environment of 1974 at -9.1%.
Over this 40-plus year period, the results become fairly astounding. The graph below shows the cumulative return of the Sell in May and Buy Treasuries Portfolio, a Long Treasuries portfolio, and the S&P 500.
In my related article, I described some previous academic research on this phenomenon, which highlighted summer vacations and even seasonal affective disorder as potential causes of this calendar effect. While this "Sell in May" seasonality has held across many markets over long time intervals, it could certainly be a spurious correlation that will reverse over even long time intervals. An exogenous shock like the current virus-related economic slowdown and market sell-off could certainly swamp the impacts of any seasonality.
Equity markets have still posted positive returns on average, in this weaker semi-annual window, it is just that stocks have generated much more of their return in the November to April period. It is difficult to dismiss any strategy that has beat the market by 3% per year with less variability, which is why I highlight the strategy in this piece. Long-term investors should still simply be trying to capture the equity risk premium over long time intervals, even if this demonstrable calendar effect suggests that much of that return has come, on average, from November to April.
Disclaimer: My articles may contain statements and projections that are forward-looking in nature and, therefore, inherently subject to numerous risks, uncertainties, and assumptions. While my articles focus on generating long-term, risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.
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