Recs
By Alex Dumortier | More Articles April 30, 2012 | Comments (32)
Around this time of year, pundits and commentators invariably trot out the recommendation to "sell in May and go away," on the basis that returns from May through September have historically been awful relative to those earned during the complementary months. There is no shortage of folk tales in investing, so in the spirit of a superb book I'm currently reading -- Expected Returns by Antti Ilmanen -- I thought I'd listen to the data instead. Before you liquidate your stock portfolio, I recommend you review my findings below.
We're off to the races!First, a bit of market history: "Sell in May and go away" did not originate on Wall Street, but rather in the City, London's financial district. In fact, the full 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.
As far as I know, the data that are most widely cited by investors and brokers regarding this phenomenon are that of Ned Davis Research (not so for academics -- the seminal paper in that realm is Bouman and Jacobsen's The Halloween Indicator (link opens PDF file).) The following table contains one of NDR's findings regarding the S&P 500 (INDEX: ^GSPC ) :
Current Value of $1,000 Invested in the S&P 500 Beginning on April 30, 1950*
Source: Ned Davis Research. *At March 31, 2012, does not include dividends. **Money is invested in stocks from Sept. 30 through April 30 annually and is in cash (no yield) during all other periods.
The numbers certainly look impressive: Stocks' price appreciation occurred almost exclusively (on average) during the period October through April. By comparison, holding stocks from May through September appears to have barely preserved the nominal value of the initial investment over a 62-year period!
Hold onI'm perfectly willing to believe that there is a seasonal component to stocks' price appreciation that is inconsistent with efficient markets, but these data aren't enough to judge the efficacy of a seasonal switching strategy. In that regard, NDR's methodology suffers from several shortcomings: For one, it assumes that when the money isn't invested in stocks, it earns no return whatsoever instead of being invested in Treasury bills. Furthermore, their data do not account for dividends, a critical component of stock returns. Finally, there is no benchmark data corresponding to a straightforward "buy and hold" strategy.
The numbersIn order to address these issues, I performed my own calculations, using data series from Ibbotson Associates (a unit of Morningstar) that begin in 1926. The following table contains the results of my analysis:
S&P 500: Annualized Return (including dividends)
April 30, 1926 to March 31, 2012
Source: Ibbotson Associates, Standard & Poor's, Federal Reserve Bank of St. Louis, author's calculations.
And your winner is...There are two key observations here:
The "sell in May" strategy soundly beat the converse strategy, with a margin of outperformance that exceeds 3 percentage points on an annualized basis.
However, "Sell in May" underperformed buy-and-hold; in fact, the outperformance of buy-and-hold is understated because the returns in the table assume no transaction costs and no tax impact. Investors selling in May incur taxes on short-term capital gains and higher transaction costs than their buy-and-hold counterpart.
About the sameIf you're clinging to the notion that "sell in May" could yet be superior to buy-and-hold on a risk-adjusted basis, you should know that both strategies have identical Sharpe ratios of 0.12 (the Sharpe ratio measures the incremental return that an asset or strategy generates per unit of volatility). That's not surprising, given that depending on where you are in the calendar, "sell in May" is either equivalent to buy-and-hold or simply earning the risk-free rate.
I think it's quite likely there is a seasonal effect to stock price appreciation that is more than simply a spurious historical observation. However, that's far from enough justification for reducing (much less eliminating!) one's exposure to stocks as May rolls in. The primary consideration when deciding one's allocation to stocks should be valuation, not the date on the calendar.
Overvalued stocksRight now, U.S. stocks look at least somewhat overvalued, based on the Shiller P/E, which uses a trailing 10-year average of real earnings. Furthermore, I think we can expect a change in volatility regime as the year unfolds, with the exceptional uncertainty linked to the European sovereign crisis simply biding its time to manifest itself. As such, an underweighting in U.S. stocks is prudent for those whose equity exposure is in index funds such as the SPDR S&P 500 ETF (NYSE: SPY ) or the Vanguard S&P 500 ETF (NYSE: VOO ) . Investors who buy individual stocks based on a bottom-up fundamental analysis, on the other hand, need not be concerned. If you're in the latter camp, I recommend you take a look at "The Stocks Only the Smartest Investors Are Buying."
Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool has sold shares of SPDR S&P 500 short. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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I say let the fools (not us) sell their stocks. When the prices of some rock solid stocks come down, we buy more, thus increasing the value of our portfolios and watching the other guys scratch their heads wondering why the values of their portfolios can't keep up with ours!!!
The key to selling in may is following Buffett "be greedy when others are fearful". An analysis that shows more aggressive buying during the may-september would offer superior returns. So while everyone is selling one should be taking their stock at cheap prices while they put it on sale all summer long. Keep your longs and just add!
If you have long term gains and low commissions then booked your gains now if you are fully invested.
I have sold off almost 20% of my stocks that I feel may be shaky with high prices. Another important factor is that 15% LT calial gains is going away this year. In fact their might be a run to the exits this fall in anticipation of this.
Read above "15% LT capital gains...."
Don't forget the fact that if you buy in May and sell in October, you are in the market 5 months. If you do the other, you are in the market 7 months. That's a 40% increase in time and more than neutralizes Alex's (improved) findings.
"That's a 40% increase in time and more than neutralizes Alex's (improved) findings."
What do you mean by "neutralizes" here -- can you expand?
Alex, I am curious as to why you did not crunch the second set of numbers -- the ones that compared rates of return from 1926 to the present -- based upon the same time period as the first set that spanned 1950 to the present. Was that data not available from Ibottson? It seems like a closer apples-to-apples comparison would use the identical time frame, assuming the data is available.
@budro2201
I did crunch those numbers, too, and had originally included them, but left them out of the final version for multiple reasons (space constraints, longer periods tend to be more representative, etc.)
It would not be an apples-to-apples comparison anyway due to the differences in methodology that I describe in the article. In case you're interested, the results over the time period 04/30/1950 - Q1 2012 are:
Sell in May, buy back in October: 11.3%
Buy in May, sell in October: 4.3%
Buy-and-hold 11.0%
the "sell in May" strategy appears to be superior for the last 62 years - changes your conclusion considerably. Odd that you compared two different time frames in the original article. I think more recent time frames are more representative as long as they are long enough to average out short term peaks and valleys. The current market is a lot different from pre-WWII market - hedge funds, mutual funds, ETFs, bear raids and massive computerized trading have changed the game.
The market from 1994 to present is not the same as your father's market. The hedge funds- EFT's have created casino type trading. How does the calculation look if you compare the last 20 years?
Should be ETF's- exchange traded funds..
Also- "puts and calls" started when?
@thefreeb
The 30bps in outperformance for "sell in May" since 1950 would quickly melt away once you factor in transaction costs and taxes.
@silverfox67
Today's market is different than your father's market -- but it's not easy to say how it is different with regard to impact on the comparison of two different strategies. In the absence of a much more detailed analysis, I don't think it's unreasonable to assume that the longest timeframe is the most representative in this case.
How about count your dividends all summer long and go bargain hunting in October... October had one of the best days to buy all last year. Personally, I recently cashed out of a short term holding and took my gains in preparation for a little bargain hunting down the road. All it takes is for the sky to fall for a couple days and you have a buying opportunity.
How many people were investors in 1926 or even 1950 and are around today? How does this strategy work for the last 10, 20 and 30 years?
You ask, I deliver:
Strategy (1) (2) (3)
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