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With markets volatile and sinking fast – and the S&P 500 flirting with correction territory – will the strategy of ‘Sell in May and go away’ work this year?
Brooke Thackray, research analyst at Horizons ETFs Management (Canada) Inc. in Oakville, Ont., who also assists with the Horizons Seasonal Rotation ETF HAC-T, thinks so.
“This is a time period where we have a lot of headwinds for the market and we ha an economy that’s slowing down,” Mr. Thackray says.
“We have high inflation. The Federal Reserve’s trying to be under control. We have governments, particularly in the U.S., that have curtailed their spending for one reason or another, and that’s not going to change. And we also have a [U.S.] midterm election.”
He adds markets tend to edge lower during that time as investors don’t like uncertainty. Another unknown is the ongoing Russian-Ukraine conflict.
“There’s a good probability the sell in May period will work this year,” he says, even with market declines so far this year.
Mr. Thackray wrote about the strategy in his book, co-authored with Bruce Lindsay, titled Time In, Time Out: Outsmart the Market Using Calendar Investment Strategies. His research found that markets tend to be weaker between May 6 and Oct. 27 and stronger between Oct. 28 and May 5.
“Over the long term from 1950 to 2021, the S&P 500 achieved a 0 per cent return in that period. In the other six-month period, the market tends to be stronger, you get bigger gains on average, and smaller losses,” he explains. “So, for a risk profile, it tends to be a better six-month period.”
But the strategy doesn’t necessarily mean dumping all your stocks and holding cash only, he says.
“Many investors interpret the sell in May period to mean that investors should move 100 per cent into cash for six months. That’s not the case,” he says.
“Overall, investment positioning tends to be more defensive and at times a large allocation to cash can be appropriate.”
There are still sector and broad market opportunities to invest in, he wrote in an April report. Defensive sectors including consumer staples, utilities, and health care hold up well during this weaker period, while riskier sectors including technology and consumer discretionary tend to lag.
Three other drivers of the sell in May strategy are that more investors want liquidity over the summer, which makes markets more volatile. Economic output tends to be lower and brokerages, who started out the year with a rosy outlook for companies, begin to see that those targets won’t be met, he says in the report.
Horizons Seasonal Rotation ETF gives an indication of how this strategy can work. The exchange-traded fund (ETF) has assets under management of $210-million and a management expense ratio of 2.22 per cent. It’s down 3.89 per cent so far this year but gained 21.4 per cent in 2021 and has a return of 7.64 per cent since its inception in November 2009.
How the strategy can go ‘awry’
Ian Tam, director of investment research, Canada, at Morningstar Inc. in Toronto, also says there’s some truth to weakness in the markets from May to October.
In a report published earlier this month, Mr. Tam studied the past 45 years of monthly returns for the S&P/TSX Composite Index and found that June to October showed lower average returns compared with other months. But selling on May 1 and buying back on Nov. 1 “goes awry” over the long term, he explains.
Looking back to the late 1970s, staying invested outperforms the sell in May strategy most of the time, he says. Most concerning is that the effects of compounding disappear. By staying invested in the index, $10,000 in 1978 would be worth $480,000 more than selling on May 1 and buying back on Nov. 1 strategy. In general, the strategy only works about 30 per cent of the time. “It doesn’t do the investor any favours,” he says in the report.
“If you just follow the strategy blindly, you would be much worse off,” Mr. Tam says in an interview. “What you’re missing out on … is compounding returns. It’s not necessarily timing the market, it’s the amount of time you are in the market.”
He adds that financial goals are reached through compounding and if you’re missing out on that, then “you’re really missing the mark.”
For the average investor, the current stock market volatility can be unnerving, he says, and it’s tempting just to sell the whole thing and come back in later.
“It may very well work this year. It may not. History tells us that it hasn’t worked,” he says. “But, really, if you’re going to be worried about this kind of thing, maybe a better use of time … is to think about how much risk that you can afford to take on.”
It could be time to revisit clients’ risk profiles and perhaps play around with the mix between stocks and bonds, he says.
The other problem with the strategy is how an investor feels if they sell in May and then the stock market rises. Additionally, if stocks are high in November, it may be mentally challenging to buy back into the market, Mr. Tam notes.
“For the average investor who’s investing for retirement, that’s really not the way to go,” he says.
Timing the market with a ‘calendar rule’
Craig Ellis, vice-president and portfolio manager at Bellwether Investment Management Inc. in Oakville, Ont., calls the sell in May strategy “dangerous.”
“We really don’t think that market timing is a productive strategy,” he says. “The reason for that is you have to predict correctly when to get out of the market … but then you also have to make a decision to come back in the market at the right time.”
From what we’ve seen, most investors are not really able to do that because no one has a crystal ball, he says. A better way to manage your investments is to look at the macroeconomic environment.
“What’s the outlook for interest rates? What’s investor sentiment like? How are earnings shaping up?” he says. “We really think those sorts of things should drive investor decisions rather than this type of calendar rule.”
With both the stock and bond markets down significantly this year, selling in May would lock in certain losses, Mr. Ellis adds.
“What happens if the market goes up? Then, you’re kind of in a bind. You don’t know what to do,” he says. “We would love to be able to remove the ups and downs of being an investor. [But] It’s just not realistic.”
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