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The ‘sell in May and go away’ strategy is baloney. But this year - do it Add to ...

Several media outlets recently focused on the “sell in May and go away” strategy for North American equity markets. The strategy assumes that they usually move lower from the end of April to the end of October - so investors should best avoid equity markets during this period.

However, a closer examination of equity market history shows that the expression is based on myth.

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First, a look at long-term data for the S&P 500 index suggests that the strategy makes sense. Thackray’s 2013 Investment Guide notes that a portfolio invested in the S&P 500 index starting with $10,000 in 1950 increased in value to $1,138,103 by May 5, 2012 simply by buying the index each year on Oct. 28 and selling the index on May 5. In contrast, value decreased to $6,602 when an investor with $10,000 purchased the index each year on May 6 and sold the index on Oct. 27. Commission costs and dividends were not included in the calculation.

Data for the TSX composite index from 1977 shows a similar trend. A $10,000 investment starting on Oct. 28 and ending on May 5 increased in value to $191,207. In contrast, value decreased to $6,183 from May 6 to Oct. 27.

A closer look at the data reveals a different picture. During the past 62 periods, the S&P 500 index gained in 50 periods and declined in 12 periods from Oct. 28 to May 5. And now the surprise: During the past 62 periods from May 6 to Oct. 27, the index rose in 38 periods and declined in only 24 periods. The index gained in seven of the past nine periods.

Data for the TSX composite index reveals a similar picture. During the past 35 period from Oct. 28 to May 5, the index gained in 27 periods and declined in eight periods. From May 6 to Oct. 27, the index gained in 19 periods and declined in 16 periods including gains in seven of the past nine periods.

Why the discrepancy between frequency of gains and percentage returns during the two periods? From Oct. 28 to May 5, a series of recurring annual events have a favourable impact on equity markets including seasonal economic data, tax-related events, annual meetings, annual reports, industry specific events and holidays. From May 6 to Oct. 27, annual recurring events influencing equity markets are less frequent, trading activity normally is lower and volatility is higher.

In other words, frequency of equity market gains are virtually random from May 6 to Oct. 27. The data also shows that the largest gains during the year historically have happened between Oct. 28 and May 5 and the largest losses during the year historically have happened from May 6 to Oct. 27.

The bottom line is that the “sell in May and go away” phenomenon is a myth. Profitable opportunities in equity markets exist from May 6 to Oct. 27, but risks are higher and returns are less dependent on annual recurring events. Selected sectors such as gold and biotech are possible alternatives during this period.

The preferred phrase to describes the market’s annual seasonality is “buy when it snows, sell when it goes.” Buy North American equity markets when the snow normally begins to fall in late October and take profits in early May when the snow finally has gone in most areas of the U.S. and southern Canada. The phrase also implies that investment opportunities are available in sectors rather than general equity markets during the May 6 to Oct. 27 period.

What about this year? Equity markets on both sides of the border have a history of moving higher during the month of April in anticipation of first-quarter reports. Of greater importance: most first-quarter reports are released at annual meetings when chief executive officers love to offer encouraging comments about company prospects for the current year. During the past 62 years, April has been the strongest month for the Dow Jones industrial average and second strongest for the S&P 500 index.

A word of caution this year: Consensus estimates show that first-quarter earnings reports released by major U.S. and Canadian companies will be less than exciting. Consensus earnings estimates for the 30 Dow Jones industrial average companies shows an average (median) gain of only 3.1 per cent on a year-over-year basis. Prospects for Canada’s top 60 companies are less encouraging. Average (median) shows no change on a year-over-year basis. The historic move higher by equity markets in the month of April is in doubt this year.

Technical indicators for the S&P 500 index, Dow Jones industrial average and the TSX composite index also are flashing a warning sign. Since Nov. 16, the S&P 500 index is up 16.8 per cent, the Dow Jones industrial average has gained 16.9 per cent and the TSX composite index has advanced 8.4 per cent. Short-term momentum indicators are overbought, but have yet to show significant signs of peaking.

Ironically, “sell in May and go away” likely is a wise strategy this year. My best guess based on current technical data and the likely response to first-quarter reports is that North American equity markets willenter into at least a shallow corrective phase before May 5 of this year. Investors holding North American equity index ETFs are watching technical signs closely for a reason to take seasonal profits.

Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. Daily reports are available at http://www.timingthemarket.ca/ . He is also a research analyst for Horizons Investment Management Inc. All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management.

Follow on Twitter: @EquityClock

 
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