If you sell your clients' stocks in May and go away through October, you'll probably hurt their performance. But there's actually some causation to the correlation between stock returns and the half-year that started this month.
The Standard and Poor's 500 stock index has averaged a 9.9% annual gain in the 25 years since the end of 1990, according to Sam Stovall, U.S. equity strategist for S&P Global. (That's with dividends reinvested).
Had you sold all your stocks in May and invested the proceeds in three-month Treasury bills through October, you would have earned an average annual rate of 8.9%, albeit with much lower volatility, Mr. Stovall said.
But
Jeffrey Hirsch, editor of the Stock Trader's Almanac, notes that in election years, May ranks 11th in monthly performance for the Dow Jones Industrial Average. September remains the worst month of all, and five of the past 10 bear markets have ended in October.
“Since 1950, 'sell in May does beat buy and hold,' Mr. Hirsch said. “And it's not just about beating buy and hold, it's about avoiding the times when the market is likely to have its worst days. Avoiding the worst days is more important than getting the best days."
LACK OF INFLOWS
Is there any particular reason why the May though October period tends to be so dreadful?
“It's not capital flight in summer — it's lack of inflows,” Mr. Stovall said. In the beginning of the year, pension funds tend to add to their investments, and those who get
tax refunds typically get them early in the year. In addition, technology stocks tend to do particularly well in cold weather, in part because of the Christmas season and in part because many IT departments have to spend their budget by the end of the year or see the money go elsewhere.
In contrast, flows to mutual funds tend to tail off after the first few months of the year. College tuition bills come due in August. And by September and October, many funds are busily remaking their portfolios, jettisoning losers and buying winners so their holdings look smart for the end of the year — a practice known as “window dressing.”
Mr. Stovall found another unsettling thing about the “sell in May” strategy: It has only outperformed buy and hold 24% of the time since the end of 1990. But some variants have been more successful:
• Buy bonds in May. Investing in the Barclay's Aggregate bond index from May through October boosted returns to an 11.3% aggregate rate, and cut the portfolio's standard deviation from 18.1 for buy and hold to 11.9. The strategy has beaten the buy-and-hold strategy just 44% of the time, however.
• Buy low volatility in May. Jumping to the S&P Low Volatility index from May through October boosted returns to 11.9% annually and cut standard deviation to 15.0. Its success rate against buy-and-hold was 56%.
• Buy health care and consumer staples in May. Those two defensive sectors hold up well in punk markets, and boost the “sell in May” strategy's return to 13.1%, Mr. Stovall said. Standard deviation fell to 14.1, and the strategy had a 60% success rate.
Low volatility stocks are now more expensive than their historical norms, thanks to the recent popularity of the strategy. But the S&P Low Volatility index is rebalanced every quarter, with overly hyper stocks getting bounced from the index. Those stocks, typically, are the most overpriced.
Selling stocks every six months, of course, is something few advisers would do. You'd rack a big tax bill and goose your trading costs as well. Nevertheless, the market's performance in the worst six months does have some rationale behind it.
“You can't just say it's investors focusing more on their tans than their portfolios,” Mr. Stovall said.
