‘Sell in May and go away – Let the statistics do the talking.’

Author: Ryan Derks – Ravenna Capital, 2015

Every year about this time people are looking towards summer break. However, the summer break I’m writing about here is a different type. Specifically, a break from the stock market. ‘Sell in May and go away’ is a seasonal strategy for investing in the stock market. Unlike most strategies that depend on either, 1) fundamental strength of a business, or 2) technical indicators, this Seasonality strategy is based purely on statistics. The strategy is one that is gaffed at by many of the biggest known investment players and conversely, held with an unbreakable faith by those who believe in it. Common arguments mention risks involved with investing, market fluctuation and possible loss of investment. Unfortunately, there is no assurance any specific investment strategy will be profitable. An informed investor should know the importance to carefully consider the risks and possible consequences involved with investment decisions; a Registered Representative can help you with this. There is very little grey area for love among the investment community for the Seasonality strategy.

What is it and how does it work?

As explained by Investopedia.com, “Seasonality is a well-known trading proverb that warns investors to sell their stock holdings in May to avoid a seasonal decline in equity markets. The “sell in May and go away” strategy is that an investor who sells his or her stock holdings in May and gets back into the equity market in November – thereby avoiding the typically volatile May-October period – would be much better off than an investor who stays in equities throughout the year.”[1]

Quick history lesson: “Sell in May and go away” did not originate on Wall Street, but in London’s financial district. Actually, the original saying is “Sell in May and go away; come back on St. Leger’s Day.” The St. Leger Stakes is the oldest of England’s five horseracing classics and is the last to be run in September. Many traders would sell their holdings in May time and go to enjoy their summer. Then, towards the end of summer the St. Leger’s horse race took place. Trader’s would use this event to signal that it’s time to get back to trading the stock market.[2]

Seasonality forms around the idea that you are only invested for roughly six months of the year, the strongest for the stock market. You buy-in once during the fall, traditionally November 1, and sell in the spring, traditionally May 1. The next six months can be spent in cash, bonds, or any other similar safe investment. Statistics shows the reason why. Think about this: since 1950, from November 1 to May 1,the Dow Jones has not had a loss in 54 years out of 64 years. [3] That’s an 86% success rate.4]

Also worth mentioning, of those ten down years only three times was there a double digit loss: The stock market crash in 2008 (-12.4%), the OPEC oil embargo in 1973 (-12.5%), and the Cambodian invasion in 1970 (-14%).This would mean that without these unanticipated events Seasonality has not had a double digit percentage down year in the 1950 example. [3]

A closer look at the ingredients.

Although there is no 100% certain answer why Seasonality works so well, there are quite a few big events happening between those months. To name a few:

“Halloween, Thanksgiving, Christmas(and related religious holidays), NewYears, Valentine’s Day, St. Patrick’s Day, Easter, and Mother’s Day all come within those months.

Black Friday and Cyber Monday Sales

Back-to-school spending

Employers making contributions to employee retirement plans; nearly all of which is directly invested into the stock market – 401k, 403b, 457, 401a, Defined Contribution or Benefit, etc.

Employers pay bonuses at year-end.

Tax refunds arrive in early spring time.

Small business owners, who make up a majority of business in America, close their books and pay themselves at year-end/early spring.

Publicly traded companies pay quarterly capital gains and dividends; many of which are reinvested. Many companies will also pay a ‘bonus’ dividend if their company has done exceptionally well. “[5][7]

So yes, there is a lot of money moving in the economy between November and May. Just the first three listed make up nearly 40% of annual spending. “November and December is the biggest time of year for retailers of all shapes and sizes. Retail sales during these two months can account for as much as 20-40% of a retailer’s annual sales.”[5] Think about how many things you spend money on in just #1-3. As for the other 5; where do you think that money goes? Probably not under a mattress. Most likely it is being spent, invested, or paying debts. All of which are great things to help the economy move forward.

These answers only create reasons for why ‘Sell in May and go away’ would work in America.

What about the rest of the world? A study published in American Economic Review in 2002, concludes, “Surprisingly, we found this inherited wisdom of ‘Sell in May’ to be true in 36 of 37 developed and emerging markets. Evidence shows that in the UK the seasonal effect has been noticeable since 1694.”[6]

Want more? Even more strange is the consistency of the Seasonality strategy after becoming very well known since the 1980s. Sy Harding, president of Asset Management Research Corp., reports this: “Academic studies have been unable to find the cause of the annual seasonality, only that it is remarkably consistent, has been consistent for several hundred years, and unlike many other patterns has remained robust even after becoming well-known, is not related to ‘data-mining’, and its performance is not due to taking excess risk, indeed is exposed to only 50% of normal market risk.”[7]

The overlooked importance of percentages.

Remember back to when you were in school or to last semester if you’re currently a student. If you get all As and Bs on every homework, quiz, and test, you have a very good chance to finish the class with an A. However, if you get just one D on an exam, no matter how hard you try, the odds are against you finishing the class with an A.

The same principles apply to the Seasonality strategy and investing in general. No, it won’t outperform the market every year. That is a fool’s errand. This strategy really excels in consistent gains and consistent avoidance of loss and volatility – volatility which is much more apparent in summer months, historically. For instance, think back to the stock market crash in 2008. It wasn’t until the end of 2012 where the average investor finally broke even. Nearly four years! Just to get back to even!

Source: Google.com/finance showing Dow Jones

Now compare Seasonality’s ‘Sell in May and go away’ to buy and hold from 2008 – 2013[7]:

Date: Seasonality(Dow Jones): Result of $1,000: Buy and Hold(Dow Jones): Result of $1,000: 2008 -3.6% $964 -33.84% $661 2009 -4.2% $923 18.82% $786 2010 12% $1,034 11.02% $872 2011 15.8% $1,197 5.53% $921 2012 7.7% $1,289 7.26% $987 2013 18.7% $1,531 26.5% $1,249 Result +53.1% +$531 +24.9% +$249

Like the poor grade on your exam, the effect that percentages carry forward can be killer. A side effect of trying to outperform the market is that you have a higher chance to ride the downturns as well. This is a small example, but the idea of ‘avoiding large percentage losses’ still applies across the board.

Like anything, ‘Sell in May and go away’ has it’s critics.

Yes, it’s no secret that the majority of times when Seasonality or ‘Sell in May and go away’ is written about it’s mostly a fluff piece just to fill space and the article will usually end in some manner of dismissing the whole thing because it seems too easy. It is hard to make ground on different ideas when you have individuals winning Nobel prizes for things like Modern Portfolio Theory or Efficient-Market Hypothesis. In fact, you may not see any well known financial guru endorse this strategy.

So what do the critics have to say? Well a lot, actually. A quick Google search will show a few headlines of: “Why ‘Sell In May’ Doesn’t Work”, “Why ‘sell in May and stay away’ might be terrible investment advice”, and “17 reasons not to sell in May and go away”.

Some things to take into account when considering this strategy:

The amount of short-term gains is lost due to taxes. A short term gain means you will be taxed at your current tax rate which means you will shave off some of your gains due to taxes. This can be true for non-IRA accounts.

The strategy is based on averages which mean extreme swings high or low will throw an investor off. Some years, such as 2013, the stock market will continue to go up every month with no downturns. An investor using buy-and-hold here would have done better than a Seasonality investor. Also, some year have human influence that can affect returns such as the three examples provided above regarding the 2008 stock market crash, the OPEC oil embargo, and the Cambodian invasion.

It’s pure randomness and that no one knows when to start, which is true for everyone who invests in the stock market. Yes, this is true for every investor. John Maynard Keynes, the famed economist whose ideas are still held today, said “the stock market can remain irrational longer than you can remain solvent”. ‘Sell in May and go away’ is exposed to this random factor.

Central Bank investment in an economy will throw off expected results. When you have the EU and USA along with the emerging BRIC nations all trying to grow while keeping a stable economy there will assuredly be a few times when one group makes a large move that affects everyone else. Unfortunately, everyone who has a dollar invested in any stock market is exposed to this particular risk.

Being out of the market for six months means missing out on potential gains. Which means you won’t do as well as just simple ‘buy and hold’. There have been years where the buy and hold worked better and vice versa. Because this is a strategy that may not work for all investors; do the standard considering of your objectives, risk tolerance, and time horizon.

Trading costs. This strategy requires two trades per year. This would incur two buy and sell costs. Some may see this as too much trading or too much cost. Be sure to check the cost to you for trading.

Final Thoughts.

There is no 100% solution of how to make consistent returns in the stock market. Let me repeat that – there is no 100% solution of how to make consistent returns in the stock market. Remember: past performance is no guarantee of future results. But as was mentioned earlier, a strategy with an 86% success rate since 1950 looks pretty attractive. This is just one strategy; it’s best to compare all options. Never stop looking for an answer and never stop asking questions. The results are the one thing that no matter how much time you spent in academia, or how many years you’ve been trading, or how many letters you have behind your name, will still do all the arguing for you.

Disclosure:

Investment Advisor Representative of and securities offered through Berthel Fisher & Company Financial Services, Inc. (BFCFS). Member FINRA/SIPC. Ravenna Capital is independent of BFCFS. Our firm does not provide legal or tax advice. Be sure to consult with your own legal and tax advisors before taking any action that may have tax implications. The interpretations and organization of these ideas are the confidential thoughts of Ryan Derks and do not represent the opinions of Berthel Fisher & Co. Financial Services, Inc. This article may not be re-published without prior express written permission – just write a message if you’d like to reference this article.

References:

[1]: http://www.investopedia.com/terms/s/sell-in-may-and-go-away.asp [2]: http://www.telegraph.co.uk/finance/personalfinance/investing/10021472/Does-the-sell-in-May-trick-really-pay.html [2]: http://money.usnews.com/money/personal-finance/mutual-funds/articles/2015/04/28/should-you-sell-stocks-in-may-and-go-away [3]: https://www.fidelity.com/learning-center/trading-investing/technical-analysis/sell-in-may-and-go-away [4]: http://www.cnbc.com/id/101630987 [5]: https://nrf.com/sites/default/files/Documents/NRF%202014%20Holiday%20Survival%20Kit%20REV.pdf [6]: http://www.emergingmarketsillustrated.com/wp-content/uploads/2013/04/HalloweenIndicator.pdf [7]: Seasonality results taken directly from Asset Management Research Corp.’s Seasonality performance. http://www.streetsmartreport.com/sts Note: AMRC uses MACD signals instead of just relying on Nov 1 and April 30.

Further Reading: