Sell In May (2): A Strategy Worth 33% A Year Since 2002

Includes: EWG, EWQ, GLD, QQQ, SPY, TLT
by: Fred Piard

As this article is a sequel, you may want to read the first episode here. Some of its comments are also of interest.

Germany has produced great things: among them nice cars and a volatile stock market. Let's focus on the latest:

This is a 5 year chart of the German DAX index (yellow) vs its neighbor the French CAC (blue). Not only is the DAX stronger, but it amplifies ups and downs. An ETF Proxy for the German Market is EWG, and EWQ for France.

Let's have a look at DAX vs Nasdaq (blue) on a shorter time (1 year):

DAX is weaker now, but an amplification phenomenon is quite obvious again. I had the idea that this amplification would also magnify seasonal effects.

Let's replace QQQ with EWG in the "QQQ-TLT" strategy described in my latest article. The holdings of EWG are different from the DAX, but it is the simplest way to play German stocks as a whole. I summarize: long TLT in January, February and from May to September, long EWG in April, March and from October to December.

Now let's compare the results of the new strategy with the former one, TLT, SPY and GLD as a proxy for gold. Here are the compound returns using data from Reuters (please forgive me if I missed decimals and tell me in case of a bigger mistake).

mouse over to see full chart

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Average
SPY+Div. -22.3 21.4 9.1 8.8 11.5 5.4 -34.2 29.4 12.8 2.4 4.43
GLD 23.1 22 7.5 23 18.7 31.4 2.8 27.8 24.1 11.6 19.2
TLT 18.3 2.2 9.4 8.6 2 9.6 34.4 -22.3 8.3 33.9 10.44
QQQ-TLT 20.2 30 18.8 2.7 15.4 5.4 -6.1 41.5 44.7 48.9 22.15
EWG-TLT 35.3 65.3 25.4 7.2 44.3 23.6 -5.9 37.1 36.5 62.5 33.13

In 10 years our EWG-TLT strategy has an average return of 33% a year, a Sharpe ratio about 1.3, a max drawdown about 40% (like QQQ-TLT) and its max drawdown period is just above 1 year (significantly better). The way I use Kelly's formula (I'll write an article about it) gives the same result: don't invest more than 12% of your account on that, 8% being a conservative bet.

Disclosure: I am long TLT.