May is only half over, but it’s more than time to call “sell in May and go away” a losing strategy.
That’s not just because the market is on a pace to double its year-to-date returns this month, meaning that someone who bailed out at the end of April already is feeling regrets.
Instead it’s because market axioms and rules of thumb tend to be more about comfort than investing logic, and the comfortable path seldom is the best one for most investors.
For proof, consider the “sell in May” concept and the numbers that prove it to be mostly hogwash, but why those flaws don’t stop investors from considering it a real strategy.
First, some background. While it’s unclear who first coined the poetic advice, it’s clear why the strategy came up and how the phrase has come to mean something completely different over time.
The strategy is based on the historical results of the stock market from May through October, compared with outcome from the other six months of the year. The Stock Trader’s Almanac has shown that, since 1950, the Dow Jones Industrial Average has had an average return of 0.3 percent from May-October, compared with a 7.5 percent gain in the November-April time frame.
Those results don’t include transaction costs and taxes on any profits — which academics can avoid but investors can’t — but they also show that the idea is less about dumping stocks to avoid summer-fall losses (0.3 percent still represents a gain) than to sidestep volatility.
Historically, trading volumes are lower during summer vacation months, and stocks tend to be more volatile at times when there is less liquidity in the market.
But the entire idea involves thinking like a trader, where the real problem is that the slow summer months show less of any sort of trend. Traders like trends; the point of selling in May for a trader is that without a strong trend and with a track record of small gains, it’s not worth it to be in the market for that half of the year.
Over time, however, the public saw it as a statement that the market is a loser from May through November, helped along by the perception that many of the market’s worst days have come in October.
That’s not what the research shows. Slow, yes; loser, no.
Jack Ablin, chief investment officer at BMO Private Bank, started testing the market maxim a few years ago and has updated it since. He went back to 1900 on the Dow and compiled two price-appreciation-only portfolios (so no dividends were included), one for each six-month period, starting with $1,000 in each.
The May-through-October portfolio grew to $2,402 as of October 31, 2014, according to Ablin, while the November-through-April portfolio had turned its $1,000 into $134,151 as of April 30, 2015. Ablin noted that the bulk of the discrepancy occurred in the last 55 years, as both portfolios stood at around $3,000 entering 1960.
It still doesn’t make “sell in May and go away” a viable strategy, largely because no one can really say why it “works.” Moreover, the question shouldn’t be whether it works, but whether it is superior to buy-and-hold for a long-term investor.
Further, the Dow is a lousy, antiquated market index; it supports the superior results for the market from November–April, but that doesn’t make it meaningful.
Russell Investments last week released a study showing that over the past 20 years, the large-cap equity market measured by the Russell 1000 has been positive in 14 of the past 20 years, or 70 percent of the time. It’s only been up in 11 of those 20 years compared with the Russell 2000, which measures small-cap stocks.
But no one ever said “Sell your small-company stocks in May.”
You can test the theory against parts of the market and eventually find segments and indexes that justify it.
But the human factor most likely wipes out any benefits.
Dan Wiener, editor of The Independent Adviser for Vanguard Investors newsletter, tested the strategy rotating from the Vanguard Standard & Poor’s 500 Index fund (VFINX) to the firm’s Prime Money Market fund (VMMXX), dating back to 1976. The index fund, on average, returned 8.4 percent from November through April, while the money fund registered an average of 3.3 percent.
The “Sell in May” approach grew by an average of 10.9 percent; by comparison, buy-and-holding the index fund all year for all those years generated an annualized average gain of 11.1 percent, Wiener reported.
But those results could only be achieved by following the strategy to the letter, Wiener noted.
“Leaving the safety of cash and buying stocks at the end of October 1987 with Black Monday still fresh in investor’s minds would not have been easy,” Wiener wrote. “Nor would it have been easy to sell stocks at the peak of the tech bubble in April 2000, particularly given the fact that the (sell in May) strategy had failed in eight of the nine prior years. In short, back-tests are one thing, but investing real money is quite another.”
In short, if “sell in May” works, it’s not some gangbusters sure-shot winner.
But the bigger problem is that no one can really say why it works.
Keep that in mind as the market continues to test peaks at a time when the chorus of voices calling for a correction or pullback are suggesting investors might want to seek shelter from a building storm.
If the stock market is making you nervous entering the summer time and you feel a need to pull back, go ahead and do it, but not because you believe there’s some savvy strategy at work here.
Instead, it’s a tonic for your nerves, as it has always been.
But if you prefer to “stay put for summer and hope it’s not a bummer,” you should know that history says you’ll do at least as well as trying to avoid the summer (and fall) market blues.