The Edmond Sun

Business

April 26, 2014

The Astute Investor: Is it time to sell in May?

EDMOND — Well, here we go again with that time of year. Time for that old Wall Street saying, “Sell in May and go away.” This is the seasonality theory that suggests the market makes most of its gains from November through May and the months of May through October are generally flat or down. But is it true? While certainly not a foolproof formula, research suggests there is some merit to it and it works more often than not.

If you were to follow this theory in practice, it would mean selling all positions in late April to early May and then stay in cash until late October to early November. During that time period you wouldn’t make any money (especially with today’s near zero interest rates), but you would not lose any money if the market went down during that time period. Of course, if the market went up you would not lose money either, but you would miss out on the potential gains because you were sitting in cash. This does not take into consideration the tax consequences of selling either.

Among many confirming studies, an academic study published in the American Economic Review in 2002 concluded that, “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 United Kingdom the seasonal effect has been noticeable since 1694 (no misprint).”

A study in 2011 of the S&P 500 from 1993 to 2010 by Zacks Investment Research, was based on a slight variation of the basic Sell In May strategy. It changed the entry date to the sixth trading day before the end of October rather than Nov. 1, but retains the rule to exit on May 1. Its conclusion was that, “For the S&P 500 a buy and hold investor turns $1 on Feb. 4, 1993, into $1.96 on Dec. 31, 2010, whereas Sell in May and move into cash, counting interest on cash (the Fed Funds monthly rate), and dividends for the buy and hold, had a final wealth of $3.73, some 90.7 percent higher.  Applied to the Russell 2000 Index, the final wealth was $2.04 for buy and hold, and $4.94 for Sell in May, 141.7 percent higher.”

Of course the market does not begin a rally each year exactly on Nov. 1, or roll over into a correction exactly on May 1 each year. So what has happened to the theory lately? Many like to point out that it didn’t work for the last two years. That is true, at least to the extent that there was not a significant correction in the summer months in either year, as the Fed pumped in additional stimulus to prevent a correction from taking place. The so-called “Bernanke Put” had a positive effect.

But even against that massive Fed influence, in those years the effect of seasonality could be seen. Though there was no correction in 2013, the market made most of its impressive gain for the year in the favorable seasons, and was basically sideways in the unfavorable season. That was also true in 2012. The big question for 2014 regarding seasonality is whether it will be three straight years that it does not outperform the market?

Or will it resemble 2011, when massive QE stimulus did not succeed in preventing a 19 percent market decline in the unfavorable season, and the only thing that prevented it from becoming even worse was the Bernanke Fed rushing in to more than double the QE from $40 billion a month to $85 billion? It seems like a fair question, since the Fed is now tapering back stimulus, and this month will have it back down to $45 billion, its level of 2011 before it was doubled, and will have it down to $35 billion in May, $25 billion in June.

So what will it be this year? Should you sell in May? Beats me. You’ll have to decide that for yourself. But there are enough red flags in addition to the seasonality issue that a certain degree of caution is warranted. So far, after a lot of volatility, the market is basically flat for 2014 and has continued to avoid the 10 percent correction that history says is overdue. During the past 60 years, there has been a correction of 10 percent or more on average of every 18 months. It has now been 30 months since the last one (the S&P 500’s 19 percent decline in the summer of 2011). In addition, the second year of the four-year presidential cycle is often negative and the average decline has been 21 percent.

I’m not suggesting that you should sell, and I still think by the time all is said and done, 2014 will see the market up 8-10 percent sometime during the year. If you are an active trader, this is a dream market if you’re good at it. If you’re not a trader, then it’s probably best to just stay put. However, perhaps now is not the best time to be adding significant market exposure; or maybe you should even reduce exposure a little or hedge some of your positions. Just saying. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment adviser.

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