“Sell in May and go away” is an old Wall Street saying. It is a well-known trading adage that warns investors to sell their stock holdings in May to avoid a seasonal decline in equity markets. In Canada, we say “buy when it snows and sell when it goes” This strategy is based on the historical underperformance of stocks in the six-month period commencing in May and ending in October, compared to the six-month period from November to April.
According to the Stock Trader’s Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period.
Another paper published in the Financial Analyst Journal in 2013 studied this effect during these periods and found that the phenomenon did indeed exist for 1998 to 2012. “On average across markets and over time, stock returns are roughly 10 percentage points higher in November-April half-year periods than in May-October half-year periods,” the paper concluded.
There are many theories about why this seasonal trading pattern happens
- Lower trading volumes due to the fact that many investors go on vacation during the summer months and it also takes away potential buyers for stocks.
- Increased money flows into retirement plans during the winter months are also cited as reasons for the difference in performance during the May-October and November-April periods. This could explain the relative increased demand for stocks during the winter.
Additional positive factors for the November-April period
- Seventy percentage of economic growth comes from consumer spending. Consumers tend to spend more for home renovations during the summer, kids going back to school in September and of course Christmas spending in the fall.
- Therefore corporate earnings tend to stronger in the third & fourth quarters with reporting results starting in mid-October and mid-January respectfully.
- Investors feel more confident putting money into stocks when economic growth and earnings numbers are more robust.
Additional negative factors for the May-October period
- First quarter consumer spending and economic growth can be effected by the severity of winter weather.
- Credit card debt from Christmas spending and higher heating costs can affect the amount of money available for consumers to spend.
- Wall Street recommends a buy & hold strategy yet indulges in market timing. They use weaker economic first quarter growth and lower profits to justify selling stocks. (Reporting results start mid-April)
- Some of the biggest stock market corrections started during the months of September & October
There are limitations to implementing this strategy in practice, such as the added transaction costs and tax implications of the rotation in and out of equities. Another drawback is that market timing and seasonality strategies do not always work out and the actual results may be very different from the theoretical ones.
Although, selling everything in May and buying back into equities in November isn’t a good strategy. Being aware of seasonal patterns can assist in boosting your investment returns.
Consider these action steps:
- Rebalance your asset allocation away from high risk into safety before May (sell high)
- Allocate new purchases of stocks or ETFs during August, September and October (buy low)
- Beat the crowd and contribute to your retirement plans before their deadlines
Keep in mind, the first quarter GDP numbers and the March employment numbers come out the first week of April. Market expectations have turned negative, analysts have lowered earnings expectations and are expecting weaker economic growth.
Living in Canada, I definitely spend more time on investing during the fall and winter months. Too busy enjoying our short summer to follow the stock market.