“Sell in May and go away” is strategy that some investors are likely contemplating right now. The adage is based on the historically weaker performance of stocks during the May through October time period. Adherents shift from stocks to cash at the beginning of May and then invest back into stocks at the start of November.
Historical performance shows there are best and worst six-month periods for stocks. Stock Trader’s Almanac calculates that the Dow Jones industrial average has an average return of just 0.3% during the worst six-month period (May through October) since 1950. Conversely, during the best six months (November through April), the Dow has an average gain of 7.5%. Sam Stovall at S&P Capital IQ says the S&P 500 has risen by a mere 1.2% during the average worst six-month period, while rising 6.9% during the average best six-month period. (Sam’s numbers go back to 1945.)
Certainly, last year made selling at the end of the April seem like a prudent decision. From the end of April 2011 to the end of October 2011, the Dow lost 6.7%. Using the October 4, 2011, intraday low as the endpoint, the drop worsened to 19.1%.
As we reach the end of April this year, the problems in Europe that caused last summer’s weakness (e.g., Greece’s sovereign debt) have not gone away. Plus, Spanish bond yields have recently risen, French president Nicolas Sarkozy is in a closely contested run-off, the Dutch coalition government has collapsed and Britain’s economy is contracting. In Asia, China’s economy shows signs of slowing, and Standard & Poor’s just lowered its outlook for India and Spain. In the U.S., politicians are stuck in the deadlock of continuous finger pointing.
Even with these legitimate concerns, things could still go right or, at least, conditions could hold up well enough to support stock prices. Europe could simply muddle along, as opposed to worsen. China’s economy may slow less than forecast. The U.S. economy may maintain its uncomfortably slow, but ongoing, recovery. Plus, low valuations could limit any downside to stocks. (The S&P 500 is trading with a forward-looking price-earnings ratio of 12.9.)
You also need to consider the downside of selling stocks. Yields on six-month US Treasuries are 0.14%. Then there is the question of when you will get back into stocks. Were you buying during last August’s or October’s lows, or were you selling? What about at the start of last November?
My cracked crystal ball cannot predict how much or how little downward volatility we will see over the next six months. Given how strong the first quarter’s rally was, a summer pause in the markets would not be surprising, but a pause is far milder than a correction. Then again, if global (or domestic) economic conditions surprise to the upside, which they are not doing now, we could see more upside. What I can say is that you will be taking a risk either way, but over the long term, stocks reward those who take prudent risks.
A very sound middle-ground strategy is to make sure your portfolio allocation is still close to your targets at the start of May and the end of October. If your allocations are more than five percentage points off target, rebalance! For example, if your strategy calls for a 60% allocation to stocks and stocks currently account for 66% of your portfolio, reduce your stock allocations back to 60% and shift the proceeds into the asset class that is currently underweight (e.g., bonds). This allows you take advantage of the best and worst six-month periods by selling high and buying low, while still adhering to your long-term investment plan.