A TSX stock traderCHRIS YOUNG
Analysts say the old saw about "sell in May and go away" is likely to be bad advice this year, thanks to the strengthening U.S. economy and upcoming presidential election.
However, history shows that the adage is correct more often than not. As a rule, May through October has been the hardest half of the year to make money in the stock market.
During the past 20 years, the S&P/TSX composite index has gone up 15 times between November and April, compared with just 13 times between May and October. Similarly, the S&P 500 Index has gained ground in 16 of the past 20 November-to-April periods, compared with just 12 times during the rest of the year.
In Canada, an investor who began with $10,000 and employed the sell-in-May strategy for members of the TSX Composite index beginning in 1977 would have seen a gain of more than $176,000 up to the end of 2010. However, a contrarian who was invested in only the other six months of each year would have registered a loss of almost $3,700, according to Brooke Thackray, author of Thackray's Investor's Guide.
The seasonal pattern is similar in the United States. Between 1950 and 2010, the gain on $10,000 invested in the "good" six months of the year amounted to more than $924,000, while the "bad" six months of the year delivered a loss of more than $3,000, Mr. Thackray calculates.
There are several theories that attempt to account for this trend. One of the most prominent pins the summer swoon on the purported tendency of equity analysts to start the year too optimistic about corporate performances. According to this theory, the early rush of bullish reports gets overshadowed by writedowns at companies that miss their marks, leading to mid-year weakness in stock prices. Balance sheets then get cleaned up for the start of the new year and the cycle begins again.
Whatever accounts for the pattern, some money managers say the "sell in May" concept remains valid and they advise clients to reassess portfolios and consider more defensive holdings in the spring. But they also note the trend may be shifting as traders try to pre-empt it, selling in April and buying back into the market late in summer.
Making the picture even more complicated, this summer could prove to be an exception to the rule, with U.S. GDP, employment, manufacturing and housing data all looking stronger than a year earlier.
Ed Yardeni, president and chief investment strategist at U.S.-based Yardeni Research Inc., says investors will likely remain cautious over the next couple of months as they monitor economic data for clearer signs of a recovery and as they wait to see the effect of the end of the U.S. Federal Reserve's stimulus program.
Caution should keep the S&P 500 trading between a narrow range of 1350 and 1450 points, in advance of a summer rally that could be spurred by improving corporate earnings and economic data, he said.
Mr. Yardeni and other market watchers warn that uncertainty around the outcome of the U.S. presidential election could weigh on stocks in September and October. But U.S. markets have gained in five of the last eight presidential election years.
The sell-in-May strategy does not carry universal appeal. John Higgins, senior markets economist with Capital Economics, notes that since 1945, the U.S. market has risen on average more than 6 per cent in the November through April period, compared with an average gain of less than 1 per cent in the other half of the year. But he considers the pattern little more than historical coincidence.
Still, the next couple of quarters will prove tougher on U.S. stocks than the last six months, during which the market rose by 11 per cent, Mr. Higgins says. Among the factors he sees weighing on stocks are weakening earnings, higher-than average valuations and the winding down of the Fed's market stimulus program.