Sell In May And Re-enter When?

October 5, 2013

It’s that time of year when I remind you of the stock market’s remarkable history of making most of its gains in the winter months, while if there is a problem it usually hits in the summer or fall months. Most investors know it as ‘Sell in May and Go Away’.

Academic studies going back many decades confirm that an investor who simply bought the Dow or S&P 500 via an index fund on November 1 each year, and moved to cash on May 1, would out-perform the market over the long-term by a significant amount, and while taking only 50% of market risk.

That is even though in some years the market continues to make gains in its unfavorable season, which of course a seasonal investor misses out on.

It outperforms because when a market correction does take place in the unfavorable summer and fall months, it’s often a significant decline.

A buy and hold investor is guaranteed to run into every one of those, and will often need much of the next rally just to get back to even. Meanwhile, a seasonal investor avoids most of those corrections, gets back in for the typical winter months rally, and builds up additional profits right away.

The most common misunderstanding regarding ‘Sell in May’ is that many assume it means the market should roll over into a correction in May or June. When it doesn’t they assume it won’t work that year. However, all the pattern says is that there is likely to be a correction sometime between May and the re-entry in the fall.

Sometimes the market does roll over into a correction in May or June. Just as often, the corrections take place in the fall, with the low often in October.

For instance, the 1987 crash took place in October (as did the only other market crash of the last 100 years, that of 1929).

Three years after the 1987 crash, the 1990 bear market ended in October.

In 1997, a late summer correction ended in late October, with the Dow down 13% from its peak. A year later, the 1998 ‘mini-crash’ began in July and bottomed in October, with the Dow down 18.2%.

Even in the very positive market of 1999, a correction began in August that had the Dow down 12% at the low in October.

In 2001, the first year of the severe 2000-2002 bear market, the Dow reached a low a bit earlier, on September 21, but then launched into a significant 29% rally to the following spring. A seasonal investor would have missed the big decline that was the first leg down of that bear market, and then been back in for most of the big rally off the late September low.

In 2002, a seasonal investor would have missed most of the second leg down of the bear market. And it also bottomed in October.

In the financial meltdown in 2008, the worst of it again took place in the summer and fall, the Dow losing 30% of its value between May 1 and November 1.

In 2011, the European debt crisis, a slowing of the U.S. economic recovery, and the threat of a government shutdown, had the market topped out in May, and the bottom took place in - you guessed it - October, with the Dow down 17% from its May 1 level.

So, it’s not difficult to see how a seasonal strategy significantly outperforms the market.

A seasonal investor keeping the profits from winter rallies by selling in May, avoiding many of those unfavorable season declines, and then getting back in for the winter rallies, doesn’t have to do so very many times before a buy and hold investor can’t catch up via the few years when there is no correction in the unfavorable season.

And here we are in another October. Will a seasonal investor outperform buy and hold this year?

The Dow was up 12.2% for the year on May 1 if a seasonal investor took those profits and exited then. The market reached new highs this summer, but has been pulling back from its September peak for two weeks now. So the Dow and S&P 500 are now only 2% above their levels of May 1. It wouldn’t take much further decline to have the seasonal investor moving into the lead for the year to date.

But the jury is still out.

We are in spooky October, with a battle underway in Washington over a budget agreement and raising the debt ceiling, and the government shut down over it, along with signs of the economy slowing again. But so far the market is holding up fairly well, certainly showing no panic.

So we shall see.

By the way, these observations are in regard to the basic Sell in May (re-enter November 1) strategy.

However, obviously the market does not launch into a new rally on the same day each fall, or top out on the same day in the spring. My own seasonal strategy, introduced in my 1999 book, utilizes the short-term technical indicator, MACD, to indicate whether the market is still in a correction as the entry date approaches. If MACD is on a sell signal we delay the entry until it triggers its next buy signal. Last year, our re-entry signal by our seasonal strategy did not take place until November 28.

MACD is available free on a number of websites. At the current time, it is on a sell signal. The question is whether it will still be on a sell signal when the calendar date for re-entry arrives.

By either strategy, here we are in October and aware of its history of seeing market lows.

If there are ever times to be cautious this is one, until it is seen how this October works out, and when the seasonal re-entry indicates that risk has lessened.

Sy is president of and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.

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