May is a fine month if you're a gardener or a baseball fan. But for investors, it has a reputation for kicking off the worst six months for the stock market.
Since 1950, the months from May through October have generated an average gain of just 0.3 per cent for the Dow Jones industrial average, according to the Stock Trader's Almanac. That compares with an advance of 7.9 per cent for the period from November through April.
In other words, virtually all of the market's winnings have occurred in the winter months. The rest of the time, stocks have been essentially flat. That explains why some investors prefer to “Sell in May and Go Away,” as the axiom goes.
Nobody knows for sure why this seasonal trend happens, but there are plenty of theories. The simplest explanation is that stock markets tend to drift lower during the summer when fund managers are on vacation, then rebound after Labour Day when people return to their desks and start buying stocks again.
Other seasonal factors may also come into play, including tax refunds, corporate earnings, portfolio “window dressing” and, in Canada, the end of the annual registered retirement savings plan rush.
So should you be selling in May and going away?
Before we answer that question, let's look at how the adage has performed lately. Last year would have seemed like the perfect time for the strategy to work. After all, the credit crunch hammered stocks last summer, so by selling in the spring you would have avoided the downturn, right?
That's true, but you would have also avoided the big rebound that followed. In fact, from May 1 to Oct. 31, the S&P/TSX composite index actually rose 10.4 per cent, including reinvested dividends. The Dow gained 7.8 per cent.
During the following six months from Nov. 1 through April 30 – a period when stocks have traditionally racked up big returns – the S&P/TSX slipped 3.4 per cent and the Dow fell 6.8 per cent. So in the past year, at least, the seasonal pattern was flipped on its head.
What about previous years?
As you can see from the table, selling in May was also a bad idea in 2006, 2005, 2004 and 2003 for Canadian investors. The last time the S&P/TSX fell in the May-October period was 2002. In recent years, the Dow has also shown a tendency to rise from May through October, not fall.
Clearly, even the most compelling seasonal trends can decide to stop working without warning, which is why the “Sell in May and Go Away” strategy can end up costing you money. There are at least two other reasons to be wary of trading strategies based on seasonal patterns: Transaction costs and taxes.
If you were to sell everything in May and buy back in November, the only person who would be guaranteed to make money is your broker, who would be feasting on the extra commissions. For all but the most sophisticated investors, trading too much is a good way to cut into your returns.
Capital gains taxes are another problem. Presumably, if you're such a great market timer, you'd be generating capital gains every time you sell. Those winnings will be taxed at half your marginal rate – money that goes straight to Ottawa instead of staying in your pocket.
That's why, rather than trying to play the seasons, investors are better off buying great stocks – preferably with rising dividends – and holding them, no matter what the weather happens to be like outside.
25
