Anyone who is a staunch supporter of the "Sell in May and Go Away" investment strategy should hate me for writing about it. If markets are rational enough, then any perceived strategic advantage would slowly disappear over time as it became more well known.
There have been many back-tested analyses of the tendencies of stock markets around the world to exhibit a seasonal trend. Many reports have shown that stocks tend to perform poorly in the summer months and strongly in the winter months, hence the rationale behind selling in May and sitting on the sidelines. It follows that one gets back into the market for the winter, and this is normally done around Oct. 31, which is why this is also sometimes referred to as the "Halloween Indicator."
Most people believe in the equity premium: the higher expected return of stocks versus safe investments over the long term to compensate for the higher risk. It's one of the backbones of capitalism. If there was no expected higher return for people to start and expand businesses, we would be in serious trouble. Of course, some businesses languish and fail, but some do very well. On average, there has to be a premium over the long haul.
Following that, the buy and hold strategy seems like a natural fit. Given enough time, it should outperform safe investments. As mentioned before in my columns, the equity premium can take decades to show up. It requires serious long-term conviction. Over very long periods of time, buy and hold has worked, but how many people have stuck to any investment strategy for north of 30 years? Very few.
It's been easy as of late to cherry pick time periods of 10 years in which stocks lost money, years in which you would have been better off putting your money under a mattress. But there are more 10 year periods where the equity premium was positive. And as you extend the time periods beyond 10 years, the ratio of positive equity premiums to negative increases.
It may seem that I've gone on a bit of a tangent, but bear with me.
Larry Swedroe recently back-tested the "Sell in May and Go Away" theory for the U.S. market. From January, 1926, through April, 2010, had investors followed this strategy, they would've underperformed the buy and hold strategy by 1.68 per cent (annualized).
The strategy didn't beat the market over the long haul. Does that mean it doesn't work for investors, period? Actually, no - it doesn't mean that. Mostly because investors evaluate their portfolios over shorter periods of time, and there have been stretches where it did in fact beat the market.
If you are comparing simple, rules-based strategies such as "Buy and Hold" versus "Sell in May," you can build a strong case for either of them working or not based on your data set.
My point is that for any strategy you engage in, you need a better understanding than just a few sets of back-tested numbers. Be it a complex, active strategy, a modification of the Sell in May theory, or a couch-potato strategy, you really have to understand it before you use it. Nothing works all the time.
To quote Warren Buffett, "If past history was all there was to the game, the richest people would be librarians."
Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com.
Preet Banerjee