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Sell in May and Go Away? Not so Fast.

BLOG, MARKETS & ECONOMICS  |  2 May 2016

By Jon Aldrich

May and October

Well May is here and spring is its normal unpredictable self here in Northern Illinois, with one day in the 80’s and the next in the 40’s. It is also strange this year, because the Blackhawks aren’t playing anymore and the Cubs and White Sox are both in first place. Strange days indeed.

So now that we are getting into May, let’s take a look at an old adage about the stock market that has been around forever.  It’s called “Sell in May and go away”. This old saying tells you to sell stocks in May, put your money in cash or bonds and don’t buy stocks again until November. Is there any merit to this? What could cause this to occur? If so, why doesn’t everyone do this? Does an election year have an effect?

Is There Merit To Sell In May and Go Away?

Actually, there is some substance to this. The average monthly returns for the S & P 500 from May through October, since 1950 are 0.52% while the monthly returns from November through April are 1.42%. In fact, five of the top six months (based on average monthly returns) occur in November through April.

S&P Returns Over Past 20 Years

You can also look at these statistics of the S & P 500 since 1970:

SPX Returns Since 1970

Source: The Fat Pitch Blog: http://fat-pitch.blogspot.com/2016/04/sell-in-may-and-buy-back-higher-in.html

However, we need to be a bit careful coming to a quick conclusion. Stocks fell by 37% in summer 2008, 15% in 1987, and by 20% in 1974. Thus, those three years account for the bulk of summer’s underperformance. But, those drops did occur in the May-November time-frame so we have to include them. A better barometer would be to look at the median gain of 5% in the winter versus 4% in the summer. This difference is not as great. Plus, you will also note, that summer is positive 67% of the time, which means, the odds are that the market will be higher in November and selling in May only works 33% of the time, which are not the greatest odds.  If you sell now, there is a pretty good chance that you would buy back at a higher price after Halloween.

What Could Cause This Market Anomaly?

We don’t really know the exact reasons why there appears to be some substance to this occurrence. Some theories imply that there are increased investment flows in the winter, especially near the start of the New Year, as money from tax refunds and bonuses as well as New Year savings resolutions are allocated to the market. In the fall, many mutual funds issue capital gain distributions which may contribute to demand for stocks. In the summer many investors on Wall Street are on vacation, and may close out their positions so they don’t have to worry about them while on the beach in the Hampton’s. Others may simply be out enjoying the summer and not paying as much attention to their positions as they do in the winter.

This trend in the performance of the markets had been noticed as far back as the late 1600’s in Britain and may be tied to our reliance on agriculture in the economy. Planting time, and tending to crops in the spring and summer took attention away from the markets, while harvest time and the selling of the harvest directed attention back into the markets and may have contributed to better results in the winter. This persisted for the next few centuries, and still seems to exist to this day, but maybe due to other reasons.

Why Doesn’t Everyone Sell in May?

There are a few ways we can look at this. First, in today’s market, if you sell, where do you put your money to try to earn an acceptable rate of return? Cash in the bank or money market funds is paying nil. Safe, Treasury bond interest rates are very, very low. The interest you receive from keeping your cash under the mattress is not all that high either. If you want to try to earn some yield, you could buy something like junk bonds, but they behave much like stocks anyways, so what are you gaining if you are trying to reduce your exposure to stocks? Additionally, you also risk racking up unneeded capital gains taxes if you sell in taxable accounts as well as transaction costs. Finally, as shown above, the median return between the two periods are really not all that much different.

You also have to consider that no strategy works all the time and if everyone followed this strategy, stocks would go down in May due to all the selling pressure. However, a savvy investor could take advantage of this and buy up these stocks, say in June, and reap large profits when everyone bought back in November. Essentially, once everyone follows a strategy based on an anomaly, that anomaly no longer exists.

Finally, as mentioned above, stocks have gone up in basically 2 out of every 3 years, from May to October since 1970. By selling in May every year, you are bound to miss a lot of good years, which will hurt your compounded long term returns, plus incurring additional taxes and trading fees. Do you really want to miss a summer where the market does very well, and you are sitting in cash earning 0%?

Does an Election Year Have an Effect?

It appears that a presidential election year does affect the returns from the May to October period. Both, Ned Davis Research and Mark Hulbert of The Hulbert Financial Digest have crunched the numbers and arrived at the conclusion that markets appear to do well in the summer of Presidential election years. As you can see in the chart below, since 1896 the Dow Jones Industrial Average returns over 4% in election years in the summer versus just over 1% in the May-October period in non-election years.

Election Year Boost

There is evidence that the markets tend to do a little better in the winter than in the summer. However, we do not recommend selling stocks just because it is May and buying them back in November. Especially, since 2/3 of the time the market is higher in November anyway. Plus, summers of election years are generally good times to be invested, excluding 2008, but there were other factors in play that year as we all remember.

In the end, you are much better served by keeping a diversified portfolio based on your investment horizon, long term plan, and risk tolerance than relying on an anomaly of the calendar. Heck, with the market anticipating the Cubs winning the World Series this year, it is bound to have an excellent summer.