Why Sell in May and Go Away

05/12/2010 1:00 pm EST

Focus: MARKETS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, notes that the coming six months are the unkindest in stock market history.

It is hard to say who is doing all the buying, but it is evident from the relative lack of volume in [the recent] rally that the sellers are sitting on the sidelines and are wisely biding their time. It is counter-intuitive, but rising prices attract buyers in the stock market. It seems everyone’s goal is to buy as high as possible, and buying begets buying.

It is instructive to witness what has happened lately when the sellers are motivated. The Dow’s 213-point collapse on April 27th was a case in point. This time, prices have held and, to date, have recovered. One of these days, there will not be a quick recovery. I can say this because all of the warning signs we saw late in 2008 that told us to expect a rally to begin in the spring of 2009 are telling us that we are approaching a reversal of fortune. The market is vulnerable.

A couple more “bug-a-boos” have developed. First, the market has entered its [seasonally] worst six-month performance period. The Stock Trader’s Almanac contains a simple study. If you had invested $10,000 in the Dow Jones Industrial Average beginning in 1950 but stayed in the market only during the months of November through April, your $10,000 would be worth $464,305 at the end of 2008. That is pretty impressive considering all the massacres we have been through since 1950!

If you had invested that same $10,000 but only during May through October, you would have lost $1,988 for your effort. It is clear that the bad things happen during the worst six months.

Here is a simple strategy. If you have money that cannot be moved often or are looking for a lazy but successful investment approach, invest in an index fund during November through April and then switch into money market funds until the next November.

The losing months are more interesting when you take a closer look. The worst six-month period has had some especially ugly hits during this decade. There were losses of over 15% in this time frame in 2000 and 2001. There was a decent gain in 2003 of 15%. No approach is perfect. The returns were single digits in 2005 – 2007. However, 2008 was the granddaddy of bad six-month periods with a loss of 27.3%.

Rallies will come and go during May through October, but September is never friendly. October is when most of the past financial slaughters have occurred, including the freefall during 2008 and 1987.

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