Market Note
Sell in May Works! Separating Chaff from Wheat
May 2, 2018

It is that time of the year, when the media publishes articles and TV interviews stating that “Sell in May,” does not work. This year, I have read many articles stating that “Sell in May,” should not be followed. The supporting data is often sampled over short periods of time, which are chosen to illustrate a desired perspective. Even when the data supports the concept of “Sell in May,” analysts and writers grossly misinterpret the data on a risk-adjusted basis.

A lot of financial analysts and writers have a strongly vested interest in propagating the buy and hold forever investment methodology. There is nothing wrong with a long-term buy and hold approach to investing, I along with many other analysts and academics believe that the risk adjusted returns can be improved by taking advantage of seasonal trends in the market place, including reducing equity exposure during the unfavorable six-month period from May 6th to October 27th. The dates that I use for the six-month favorable/unfavorable cycle are a bit different than the conventional six month “Sell in May” period and are based upon extensive research.

So why do some market pundits believe that investors should just stay in the stock market for the unfavorable six-month period, other than their vested interest in supporting “Buy and Hold?” Market pundits often do not properly measure the amount of risk taken to produce returns. From 1950 to 2017, the S&P 500 has been positive 63% of the time in the unfavorable six-month period for stocks from May 6th to October 27th (Thackray’s 2018 Investor’s Guide, page 57). Sounds wonderful, so why would investors try to avoid, or reduce, equities during a period that is positive more than half the time? Because on a geometric average basis, they would have lost money (average loss of 0.5%). Sure, 63% of the time the stock market has been positive in this time period, but on average, the gains have been relatively small, and the losses large relative to the other six-month period of the year. In other words, the unfavorable six-month period is a risky proposition.

If an investor wins, wins, wins again and then loses big, they could possibly lose all of their gains. We have all experienced losses, all of us. Investors know that the cost of being in the market is volatility, which for most investors means losses. The ideal scenario is for gains to more than compensate for the losses, and this is exactly what has happened over the long-period of time on an annual basis.

Separating chaff from wheat
A buy and hold approach to investing is sold on the principal that expected losses in the long-term are overwhelmed with gains. But what if it were possible to separate out the chaff (period that on average has produced larger losses and smaller gains), from the wheat (period that on average has produced smaller losses and bigger gains)? What if it were possible to experience fewer large corrections? What if it were possible to have better overall average gains? Historically, investing in the favorable six-month period and side-stepping the other six months of the year has produced a return profile for investors that has had fewer large losses, and overall better gains. Focusing on investments during the six-month favorable period for stocks (investing from October 27th to May 5th), investors have been able to separate out the chaff from the wheat and enjoy a much better risk-reward investment profile.


Does it have to be all-in or all-out?
For most investors it is not practical to be all in the stock market, or all out at the beginning of May. Investors can reduce the amount of equities in their portfolio, focus on sectors of the stock market that tend to perform well relative to the overall stock market and look for opportunities to step into the stock market on big corrections, particularly in September and October.

In the unfavorable six-month period for stocks, a number of sectors tend to perform better than the overall stock market. One of my favorite seasonal trades is the biotech trade that lasts from June 23rd until September 13th: right in the middle of the unfavorable six-month period for stocks. Gold's strong seasonal period (July 12th to October 3rd) occurs in the six-month unfavorable period. The agriculture sector starts its seasonal period in the six-month unfavorable period, and the list goes on. “Sell in May,” does not mean sell and go fishing, there are still opportunities in the stock market, and it is prudent for investors to consider adjusting their portfolios to reduce risk and take advantage of seasonal opportunities.