In the northern hemisphere, the weather is getting warmer, flowering plants and trees are showing new signs of life, and horse race fans are breaking out their Kentucky Derby finery as race day is only a few furlongs away.
But for stock market investors, the month of May has some dark clouds, at least for those who give any credence to the old saying, “Sell in May and go away.”
Is there any reason to heed that advice, or can it result in more harm than good to your portfolio? Should stock market seasonality factor into your investing strategy?
In particular, with markets in rally mode following better-than-expected earnings reports, optimism that a banking crisis has been nipped in the bud, and the possibility that inflation may be receding, do you really want to park your money in cash for the next few months?
The idea behind “Sell in May and go away" is that the stock market tends to underperform during the summer months, typically between May and September. For that reason, investors are advised to sell their stocks before this period and then get back into the market in the fall.
Underperforming Doesn't Always Mean Declining
But underperformance is not synonymous with losses.
Research by the Corporate Finance Institute found that since 1945, the S&P 500, or its predecessor index, posted a cumulative six-month average gain of 6.7% in the period between November to April. In contrast, that gain averaged around 2% between May and October.
The CFI also noted, “The S&P 500 typically generates positive returns roughly two-thirds of the time from May to October, while that percentage rises to 77% from November to April.”
There are various theories as to why the stock market tends to lag during the summer months. One explanation is that many investors take vacations during this time, resulting in lower trading activity and less liquidity in the market.
But in an era where algorithms drive trading, does that make so much sense anymore? Sure, humans have a role in programming trading algorithms, and big price moves following news developments show clear signs of humans doing some emotion-driven trading. Even institutional traders aren’t impervious to the same hope, fear and greed of retail traders.
Plenty Of Market News In Summer
Other theories posit that companies may be less active in terms of news announcements during the summer, but that doesn’t really make sense, given that companies have to issue quarterly reports at some point between May and September. If the typical quarterly calendar wraps up at the end of June, those reports are rolled out in July and August.
The biggest thing to note about “sell in May” is that weak returns are not guaranteed to occur every year, and many factors that can influence market performance beyond seasonality.
For example, in 2021, strong earnings reports buoyed summertime market gains.
In an April report, Bank of America analyst Stephen Suttmeier wrote, “May can be a weak month for the [S&P 500], but if you ‘sell in May and go away’, you could miss a summer rally. SPX seasonality back to 1928 confirms the tendency for a summer rally.“
Hold In May And Stay Put
There are a few reasons why you might want to ignore advice about selling in May, as well as any investment advice that’s passed along with a bouncy little rhyme:
- Although the stock market tends to be weaker during the summer months, there have been many instances where the market has continued to rise during this time period. Even if the gain is paltry compared to the fall and winter, why would you want to sit in cash and miss out?
- “Sell in May” ignores the fact that individual stocks and sectors may perform differently during the summer months. Some stocks may actually perform better during the summer, while others may underperform. Brokerage TD Ameritrade, citing research from the Stock Trader’s Almanac, noted that consumer staples, utilities, precious metals, and healthcare stocks often outperform in the summer.
- If investors follow this strategy blindly, they may miss gains due to important market events or news. Summertime earnings reports are an obvious catalyst, but there are certainly others, including economic announcements. By completely exiting the market for several months, investors may miss out on opportunities to profit or protect their portfolios.
- Finally, the strategy is not tailored to individual investor goals or risk tolerance. An investor with a longer-term horizon and a higher risk tolerance may be better off staying invested in the market, regardless of seasonal patterns. The decision to buy or sell should be based on an individual's specific investment objectives and risk tolerance rather than a blanket strategy that may not be appropriate for everyone.
It’s always best to have an investment philosophy, which means an approach to market principles, which in turn are driven by your need for income, your time horizon, and your risk tolerance, among other factors.
Willy-nilly selling, just because you see a certain month on the calendar, is simply an exercise in market timing, which requires that you get back in at the right time to capture gains. If investing was just a matter of adhering to such a simplistic formula, wouldn’t everybody have caught onto it by now?