Many investors have heard the saying “sell in May and go away” but are unsure if there’s any truth to it. The axiom cautions investors to sell their stock holdings in May to avoid a seasonal decline in equity markets. It asserts that people who sell their stock holdings in May and hold cash during the summer, then buy back into the equity markets in November will enjoy higher returns than average.
While this may sound compelling, does it really make sense to sell stocks in May and re-buy them later in the year?
Analyzing the claim
It’s true that, historically, there is lower trading activity during the summer than other times of the year. Reduced trading volumes can cause larger-than-normal spreads between bid and ask prices on stocks, thus creating more volatility in equity markets.
With this in mind, however, there are several considerations. The “sell in May” theory assumes two absolutes; the first being that there will be a decline during the period. This is not always the case. Over the past 10 years, the markets have gone up during this period 60 per cent of the time.
The second assumption is that stock market returns between May and October in any given year will be lower than the risk-free (money market) rate. With persistently low interest rates, it’s hard to imagine that would be true with any regularity.
Further, many investors can increase their after-tax returns by triggering capital gains at opportune times. Selling each May largely ignores tax planning, potentially causing unfavorable tax consequences.
Though many studies claim the “sell in May” adage is correct, few have approached data like the CXO Advisory Group, which recently published a study where they analyzed S&P Composite Index levels, dividend yields, and 10-year Treasury note yields from April 1871 through October 2012.
Their study found that indeed, during 10 out of 14 decades, those who sold stocks in May and re-bought in November performed better than those who held stocks from May to October and cash during the rest of the year. However, the study also found that those who held stocks all year long performed significantly better than anyone, enjoying an average six-month return of 5 per cent, while those who sold in May and went away earned just 2.8 per cent.
Those who are waiting to deploy cash in the equity markets may be able to capitalize on the “sell in May” theory by applying Warren Buffet’s famous quote: “Be fearful when others are greedy and greedy when others are fearful”.
In other words, the “sell in May” adage is so well-known that, in some cases, instead of eliminating market volatility for a period of time, people who sell in May only to re-buy in November may simply be creating opportunities for other people to buy stocks on sale during the summer months.
When investing, as in many aspects of life, the only way to beat the crowd is to be different from it. Savvy investors will sell high and buy low regardless of the time of year.
“Sell in May” is not the only trading adage. Economists have documented numerous stock return patterns related to calendar time, including those related to the month of the year (January effect), day of the week (Monday effect), day of the month (turn-of-the-month effect) and holidays (the holiday effect).It’s understandable why trading theories exist. People simply want to explain things they don’t understand, or that are largely unexplainable. The truth is, as nobody can predict the future with complete accuracy, investing in the equity markets will always involve an element of the unknown. The rest comes from sound fundamental analysis of companies and the markets in general, as well as a little luck.