Sell in May and Go Away – NO WAY!Monday, May 12th, 2014
A well-known trading adage warns investors to “Sell in May and Go Away.” In other words, sell their stock holdings in May and reenter the equity market in November. This strategy allows the investor to avoid the typically volatile May-October period. It is based on the belief that the investor who avoids holding stocks during this period will be much better off than an investor who holds equities throughout the year.
The basis of the strategy is the historical underperformance of stocks in the six-month period starting in May and finishing in October relative to the six-month period from November through April. According to data from Bank of America Merrill Lynch (BofA), since 1928, the S&P 500’s 1.9% average gain for the May-to-October period is the index’s weakest. It sharply lags the 5.1% return generated in the November-to-April period. BofA’s data also highlights the fact that historically the months from May to October pose the highest risk of a market decline of 20% or more of any six-month period. However, the general rule also does not always pan out. For example, last year, the S&P 500 rose 10% in the typically weak six-month period. Overall, the data show gains for the best and worst six-month periods. As a result, being out of the market from May through October would hamper performance on an absolute dollar basis.
It is important to remember that prior results are also not necessarily representative of future performance. They tell us what has happened in the past and indicate what might happen in the future, if history repeats itself. If past performance was always indicative of what might happen in the future, then the number of investment mistakes would fall precipitously. In addition, it is hard to comprehend why the strategy should be followed when the exact reasons for this seasonal trading pattern are unknown.
In practice, there are also a number of limitations associated with this approach, including transaction costs and the tax implications of rotating in and out of equities. In particular, following this strategy to the letter would result in all gains or losses being classified as short term, and short-term capital gains rates are higher than long-term rates. In addition, this is essentially a market timing strategy. It is very difficult to achieve investment success by timing the market (Market Timing is a Losing Bet).
At BWFA, we are looking to acquire shares in businesses we can hold for at least three-to-five years. We endeavor to minimize trading costs and keep tax bills as low as possible. In short, we have no plans to “Sell in May and Go Away.” In addition, similar to any other period, if some stocks do fall by an above-average amount during the summer months, we will be looking to see if the decline provides us with an opportunity to initiate a position in a security that we believe has the potential for outsized returns over the long term.