Why You Should Not Sell in May and Go Away

As the calendar flips to May, the U.S. stock market enters what is historically its worst six months of the year, in which it typically underperforms the November-April time frame.

This is a well-documented seasonal trend with solid historical numbers behind it. It begs the question: Should investors follow the old Wall Street adage to "sell in May and go away?"

The numbers back it up.Looking at stock market history back to 1950, most of the market's gains have been made from November to April and the market has generally gone sideways from May to October, says Jeffrey A. Hirsch, editor in chief at Stock Trader's Almanac.

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The November-April period produced an average gain in the Dow Jones industrial average of 7.5 percent since 1950 compared to an average gain of just 0.4 percent from May to October, Hirsch says.

Market lore around this seasonal trend can be traced to an old British saying: Sell in May and go away and come on back on St. Leger's Day, which refers to the St. Leger's Stakes thoroughbred horse race in mid-September, the final leg of the British Triple Crown.

"Historically, English aristocracy, merchants and bankers would migrate from the hot, sweltering city up to the country for the summer months and return after the St. Leger's Stakes," Hirsch says.

A similar pattern is seen from Memorial Day to Labor Day in the U.S. Folks are spending more time with kids and family, on the golf course, at the beach and on vacation instead of doing business deals and trading stocks.

"Investment banking and corporate meeting calendar slows down. Wall Street notoriously heads for The Hamptons on Fridays in the summer and people take long weekends and Mondays off more," Hirsh says.

The pace of capital inflows also could explain better performance numbers during the November-April period. In the beginning of the year, pension funds tend to add to their holdings and people tend to invest any year-end bonuses, says Sam Stovall, managing director at S&P Global Market Intelligence.

"If you have an IRA that needs to be fully invested by April 15 and those who get tax refunds tend to file early and often invest those proceeds. In the summertime, you don't have those types of capital inflows and investors focus on their tans (rather) than their portfolio," Stovall says.

Brace yourself. Hirsch expects this seasonal pattern to repeat again this year. "Current technical, fundamental, seasonal, sentiment and monetary policy outlooks are aligning to signal increasing odds of a turbulent worst six months this year," he says. "Lower lows and lower highs in the first quarter compared to the fourth quarter and the pace that losses accumulated in the first quarter could be a sign of further trouble."

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There are strategies to capitalize on this seasonal trend and certain sectors that tend to outperform. Consumer staples and health care are two sectors that stand up well in face of seasonal sluggishness, outpacing the Standard & Poor's 500 index, Stovall says.

"Since 1990, while the S&P 500 gained 1.5 percent May-October, consumer staples gained 4.6 percent and health care gained 4.9 percent," Stovall says.

Consumer staples and health care are traditional defensive sectors and demand for their products and services tends to remain the same no matter the economic cycle.

"There are long-only investment managers that have to be in stocks. They can't be in cash. As a result, they tend to lean defensively," Stovall says.

Options for investors. There is an exchange-traded funds rotation strategy that has outperformed the S&P 500 by 3.5 percent per year since 1990, Stovall says.

Here's how the ETF sector rotation strategy works with a hypothetical $2,000 portfolio: On May 1, put $1,000 into the Consumer Staples Select Sector SPDR ETF (ticker: XLP) and the other $1,000 into Health Care Select Sector SPDR ETF (XLV). "Sit on it until the end of October. Then, sell both XLV and XLP and purchase SPDR S&P 500 (SPY). Do it every six months," Stovall says.

Treasury bonds have performed well during the worst six months. Bonds are up 72 percent of the time since 1990 during the period, Hirsch says.

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The Stock Trader's Almanac suggests a simple and conservative switching strategy. "During the best months an investor is fully invested in stocks. Index tracking ETFs and mutual funds are an easy and inexpensive way to gain stock exposure. During the worst months, capital would be taken out of stocks and could be left in cash or used to purchase a bond ETF or bond mutual fund," Hirsch says.

Hirsch highlights a few bond funds investors can consider: iShares Barclays 7-10 Year Treasury (IEF), iShares Barclays 20+ Year Treasury (TLT), AdvisorShares Ranger Equity Bear (HDGE).

Despite the saying about selling in May, there are strategies that can benefit investors. "I always think it is best to rotate, not retreat during this season," Stovall says.

Kira Brecht is a financial journalist who writes extensively on stock, commodity, and foreign exchange markets, investing strategies, the economy and the Fed. She was managing editor at SFO (Stock, Futures & Options) Magazine for 10 years, creating digital magazine, newsletter and online content aimed at the individual investor. She began her career on the floor of the Chicago futures exchanges covering commodity markets for a financial newswire service. Follow her on Twitter @KiraBrecht.