Many investors believe that “sell in May” means they need to sell all their stocks and go all to cash when the calendar turns to May. Rather, what they truly need to do is rotate their portfolios to more defensive holdings, which may include holding some cash.
The “sell in May” adage is based on the long-term average trend of the stock market underperforming for the six-month period beginning in early May compared with the other six months of the year.
Looking at the adjusted six-month period from May 6 to Oct. 27, the S&P 500 index has produced an average loss of 0.1 per cent and has been positive 63 per cent of the time from 1950 to 2020. That’s significantly weaker than the 7.7 per cent gain and 72 per cent frequency of being positive in the favourable six-month period for stocks, which runs from Oct. 28 to May 5, during those same years.
Yet, many pundits look at the returns and frequency of positive occurrences and ascertain that because the stock market is positive more frequently than negative from May 6 to Oct. 27, adjusting a portfolio is not advantageous during this period.
On a risk-reward basis, investing in the favourable six-month period for stocks has been a lot more rewarding over the long term than investing in the “sell in May” period. In addition, most large gains have happened in the six-month favourable period for stocks while most large losses have occurred in the May 6 to Oct. 27 period.
A good way to conceptualize “sell in May” is to view it and the favourable six-month period as defence versus offence. Over the long-term, it has been advantageous to play offence, or have a higher portfolio beta, in the favourable six-month period from late October to early May. In the “sell in May” period, it has been advantageous to play defence, or have a lower portfolio beta. The offence-defence approach involves rotating between different sectors of the stock market and asset classes, as well as adjusting the percentage of cash holdings.
As such, there are several investment opportunities in the “sell in May” defensive period. Specifically, sectors such as biotech, consumer staples, health care, utilities, real estate investment trusts, government bonds, Canadian banks, technology, gold, and others have a major part of their strong seasonal period during the May 6 to Oct. 27 timeframe. In addition, broad stock market indexes such as the S&P 500 and the S&P/TSX Composite Index have tended to perform well starting in late June and into mid-July in the run-up to quarterly earnings announcements over the long term.
The “sell in May” period requires a different approach. Investing according to the seasonal trend requires a shift into different sectors of the stock market. In many cases, the seasonal opportune sectors will be defensive sectors, but not always. Depending on the circumstances and timing of different sectoral opportunities, there will be times that a cash allocation could be higher than normal. Given the weaker risk-reward relationship in the “sell in May” period, having some cash on hand at different times allows investors to take advantage of opportunities during stock market volatility.
Does “sell in May” always work? No. Like any investment strategy, the objective is to increase the probability of success. There will be times when the S&P 500 does produce large gains in the “sell in May” period. Historically, that has happened when the economy has been expanding rapidly, typically coming off recessions. Last summer, the COVID-19 pandemic bounce in the stock market started in late March and continued for the rest of the year, with the stock market performing well in the “sell in May” period. That’s because investors pushed up stock markets in response to a faster than expected re-opening of the economy and as central banks and governments provided unprecedented liquidity.
As we look ahead to the remainder of 2021, central banks and governments are expected to continue to provide liquidity for the rest of the year and beyond. There’s a strong argument that the provision of continued liquidity has already been priced into the markets and economic growth is expected to be much more subdued compared to the post-March bounce last year. Yet, it’s not unreasonable to expect the stock market to follow its long-term rhythm of weaker performance in the “sell in May” six-month period. So, on a seasonal basis, it is time to play defence.
Brooke Thackray is a research analyst at Horizons ETFs (Canada) Inc. He focuses on technical analysis and seasonal investing.