Get Ready to "Sell in May?"

04/16/2014 10:00 am EST

Focus: STOCKS

Seasonal timing expert Sy Harding updates investors on the "Sell in May" market maxim; here's the latest from the editor of Street Smart Report.

Steve Halpern: Joining us today is Sy Harding, market timing expert and editor of the Street Smart Report. How are you doing today, Sy?

Sy Harding: Oh, I’m just fine, Steven. How are you?

Steve Halpern: Very good. You’ve developed one of the newsletter industries’ top market timing records based, in large part, on your expertise in seasonal timing. In its simplest terms, people often hear the saying, “sell in May and go away.” Could you explain this overall approach to market timing?

Sy Harding: Well, Steve, the stock market has a very long history of making most of its gains each year in a favorable season of November to April, while, in years when corrections take place, they almost always take place in an unfavorable season from May to October.

The result is, is that a strategy of being in the market for the favorable seasons, and safely in cash during the unfavorable seasons, significantly outperforms the market over the long-term and academic studies confirming the pattern appeared as far back as the 1960s and 70s.

Steve Halpern: Now, you point out these academic studies and you also recently noted that there are some additional academic studies that show this pattern is not unique to the US Market. Could you tell us a little about that information?

Sy Harding: Yeah. There’s been quite a few such studies. For instance, one academic study, by Professor Ben Jacobsen of the Rotterdam School of Management in the Netherlands, it was published in the American Economic Review in 2002.

It concluded that—and I’m quoting here—“Surprisingly, we found this inherited wisdom of “Sell in May” to be true in 36 of 37 developed and emerging markets. Evidence shows that, in the United Kingdom, the seasonal effect has been noticeable since the year 1694. The additional risk adjusted outperformance, over buy-and-hold, ranges between 1.5% and 8.9% annually, depending on the country being considered, the effect is robust over time, economically significant, unlikely to be caused by data mining and not related to taking excessive risks.”

Another study published in 2012 by Gramercy Funds Management, that’s a fund that specializes in emerging markets, measured the affect of seasonal timing on emerging markets using the MSCI Emerging Markets Index as the benchmark, for the period of 1995 to 2012.

The study concluded that an investor who followed the strategy of being invested in the MSCI EM Index from November to April and exited the cash from May to November would have outperformed buy-and-hold annually by an average of nearly 610 basis points in the US dollar and 320 basis points in local currency terms.

Steve Halpern: Now, in your latest research, you suggest that investors should pay particular attention to the “Sell in May” strategy this year, in part, because it coincides with another timing strategy, which is the seasonal four year presidential cycle. Could you tell our listeners a little more about this second cycle and how the two may interact?

Sy Harding: Well, the four year presidential cycle also has a long history of the economy and stock market experiencing problems in the first or second year of president terms.

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In fact, since 1934, the average decline in the second year was 21% with some declines being considerably worse and this year is the second year of the Obama administration’s second term.

Not only does that coincide with this year’s annual “Sell in May” seasonality, but we will be entering this year’s unfavorable season with the market fully valued, if not significantly overvalued, based, for instance, on the Shiller CAPE P/E ratio and investor confidence is that extremes often associated with market tops.

For instance, margin debt is at a record high, the Investor Intelligence Sentiment Survey was recently at its highest bullish extreme since 1987. For all these reasons, I believe we have to pay special attention to some type of seasonal strategy this year.

Steve Halpern: Now, finally, there are two important points I’d like to cover. First, you point out that while seasonal timing worked very well over the long-term, it doesn’t necessary work each and every year. Could you explain that?

Sy Harding: Well, yes. In spite of the overwhelming evidence, Wall Street still refers to market seasonality not as fact, but as a theory. They point out that it’s an iffy thing since some years it doesn’t work out.

It is true that seasonal investing does not outperform the market every individual year. However, that’s a nonsensible argument against it. There’s not strategy that outperforms every single year.

That applies most emphatically to buy-and-hold, and the historical evidence that clearly shows seasonal investing substantially outperforms the market over the long-term includes those individual years when it did not outperform.

Meanwhile, an investor who holds through the unfavorable seasons can have substantial losses in those years when seasonal timing does work, which is why seasonal timing works so dramatically well if followed over the long-term.

Steve Halpern: Finally, rather than just blindly exit the market in May and reenter each November, for your timing strategy, you use a proprietary approach that fine tunes your exits and entries to the market around this cycle. Could you explain that approach that you use?

Sy Harding: Well, yes. In looking back at the various studies on “Sell in May,” it was obvious to me that the market does not begin its winter rally exactly on November 1 each year, nor does it roll over into correction exactly on May 1 each year.

In 1999, I introduced a similar seasonal strategy that utilizes a short-term technical indicator, a momentum reversal indicator known as MACD, as well as the calendar; and if used, sometimes delays the exit signal from May 1 into June, while other years it triggers the exit signal in April.

In real time use, since 1999, in my newsletter, it has doubled the market’s performance over the long-term and significantly outperformed “Sell in May,” and that’s been verified by Hulbert Financial Digest and other rating services, and it still only takes roughly 50% of market risk.

Either way, I think that investors need to be very careful with the unfavorable season this year.

Steve Halpern: Well, we really appreciate you taking the time to share your ideas with us. Thanks for joining us, today.

Sy Harding: Well, thank you, Steven.

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