2014-05-08 - Rhyme and Reason for the Month of MaySubmitted by Balanced Financial Concepts, Solon, Ohio on January 16th, 2015
Cetera Research Market Commentary: Rhyme and Reason for the Month of May
A number of websites declare May, among other things, National Bike Month, National Barbeque Month, National Hamburger Month, National Salad Month, and National Older Americans Month. The month of May boasts May Day, Cinco de Mayo, Mother’s Day, and Memorial Day, as well as the lesser known Star Wars Day, No Socks Day, and Dance Like a Chicken Day. Most have heard the saying “April showers bring May flowers” and other sayings that celebrate May as the heart of spring and early start of the summer season – at least as far as students, summer timeshare renters, beach goers and wearers of white linen pants are concerned. Amongst investors, however, there is an old adage that comes up every year – “sell in May and go away” – which, along with “the Halloween indicator” defines a theory that stocks tend to do better during the November-April period than during the six month period spanning May-October.
For a number of reasons, academics dismiss this theory; although, certain studies have shown that there is some historical truth to this observation and that it has held true for markets in over 30 countries, especially those in the developed world. Actually, in full, the saying is “Sell in May and go away. Stay away until St. Leger Day.” The phrase came from England, where St. Leger Day marked the St Leger Stakes, the last horse race of the English Triple Crown. The saying became popular in London in the 1930’s, and harkens back to a time when London traders left the city for a leisurely summer, and left markets thinly traded and more volatile until they returned in the Fall. These days, though, global markets barely seem to rest over weekends and holidays, let alone months or seasons, and the prevalence of automated and program trading certainly precludes market volumes being driven by the vacation schedules of a handful of traders.
Since 1970, the Dow Jones Industrial Average has registered an overall higher average return for the colder months (8.95%) than the summer months (2.66%). There is speculation that in summer months, earnings slow down and this pushes equity prices lower. There is also another theory that postulates that it has to do with optimistic sentiment around the holidays and into the new year, companies spending whatever is left of the year’s budget and starting afresh with new funds, and asset allocators being given new money to invest. The theory goes that this optimism becomes overextended and then wanes going into the summer months. However, there is not enough data for this to be statistically significant (hence, why it is routinely dismissed by academics), and there have been some years, such as 2013, in which selling in May and buying in October would have produced undesirable results for the year. Last year, the S&P 500 soared 10% from the end of April to the beginning of November. In the period between May 1 and May 24 alone, the Dow rose 3%. Those who exited the market on May Day would have missed out on those gains. Another recent example – if you had bought on 11/1/08 and then sold on 5/1/09, you would have lost 8.53%, and then if you had not been invested from May through October of 2009, you would have missed out on 20.04% gains.
In other words, this is another example of a trend following strategy which works…until it doesn’t. Furthermore, this approach to investing also disregards the impact of dividends, trading costs, and potential tax implications associated with the elevated level of trading. Also, the DJIA is an index which represents only a very small portion of the market and overall economy. It should not be thought of as a reasonable proxy for all stocks, nor should one conclude anything about the overall universe of stocks by extrapolating from its performance. The S&P 500 Index, a larger sample, produced similar, but less remarkable, results over the same time period.
As a strategy, however, this approach is at best a risky one, but in practice can result in unnecessary and expensive transaction costs to implement. Additional concerns include higher capital gains taxes as short term gains are taxed at higher rates than long term ones, and the emotional cost of worrying about whether market movements in any given year will be conducive to this strategy’s success or whether macroeconomic, geopolitical or anomalous events might override historical patterns. As well, in times such as these, investors and companies are being enticed through extremely low interest rates to spend, and investors are not being rewarded to save, which begs the question of what to do with all of the cash for the six month period in which one is supposed to be out of the market.
Instead of trying to time market entry and exit every six months, investors would be better served by stopping to smell the flowers on May Day, celebrating Star Wars (May the 4th be with you), enjoying barbeques and bike rides, and perhaps even wearing no socks and doing a chicken dance – anything but looking toward old clichés for investment advice. We continue to believe that a well-diversified portfolio offers the best protection against short term volatility, and recommend that prudent investors maintain a long term investment horizon, contribute to portfolios on a regular and consistent schedule, and maintain a disciplined approach to rebalancing.
The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. This does not represent any specific product. It is not possible to invest directly in an index.
This information compiled by Cetera Financial Group is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment. The opinions expressed are as of the date published and may change as subsequent conditions vary. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision.
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