'Sell in May' with a New Twist

05/03/2013 9:45 am EST

Focus: MARKETS

Sam Stovall

Chief Investment Strategist, CFRA Research

There’s no one better at making market concepts understandable, and here, Sam Stovall of S&P Capital IQ takes a new look at an old adage.

Like many stock market adages, I remember being introduced to “The Best/Worst Six Months” in The Stock Trader’s Almanac, as it relates to the Dow Jones.

I then looked to see if this seasonality was evident with other domestic and international indices. I found there was a noticeable period of seasonal strength and weakness not only for the S&P 500, but also for mid- and small-caps, as well as developed international and emerging markets.

I think the main reasons for seasonal weakness during the May to October period are reduced capital inflows, vacations, earnings reality, and mutual funds’ fiscal year-end window dressing.

This year, I have been asked if “Sell in May” still works, since the S&P 500 rose in both January and February. I found that in the 26 times since 1945 that the S&P 500 was up in both January and February (in which the market posted a full-year average total return of 24%, and was up all 26 times), the May to October performance for the S&P 500 improved from its 1.2% average gain for all years to 3.9% for these 26 years, and its frequency of advance also increased from 63% to 77%.

Regardless of whether the market started well or poorly, I don’t think it is wise to sell out of stocks altogether. History shows (for it never guarantees) that an investor has been better off embracing a defensive posture during the seasonally soft six-month period than they have been leaving the equity market altogether.

Indeed, a semi-annual sector rotation strategy outperformed a buy-and-hold approach whether you look to the cap- or equal-weighted S&P 500, the SmallCap 600, or Global 1200.

From April 30, 1995 to April 19, 2013 (the period common to all four benchmarks), had an investor owned the overall benchmark from November-April, and then a 50% exposure to each of the Consumer Staples and Health Care sectors from May to October, their returns would have significantly outperformed their relevant benchmarks, while also reducing their annual volatility. Specifically:

  1. the cap-weighted S&P 500 posted a compound annual growth rate (CAGR) of 6.3% (excluding dividends), but the strategy returned 10.0%
  2. the Equal Weight S&P 500 gained 9.3%, and the strategy returned 13.9%
  3. the S&P SmallCap 600 rose 9.5%, and the strategy climbed 14.1%
  4. the S&P Global 1200 gained 5.0%, and the strategy advanced 9.7%

Finally, I also found that this semi-annual strategy enhanced returns and reduced volatility when an investor rotated into the low-volatility subsets of the S&P 500, SmallCap 600, BMI-Developed International, and BMI-Emerging Markets Indices from May to October.

Should you believe the market faces a challenging period ahead, you may want to consider this semi-annual rotation strategy, regardless of size or region. Like whitewater rafting—by allowing the market to take you where it wants to go—you can experience both a thrilling and rewarding ride.

As always, remember that history is a guide, but never gospel.

Read more from S&P Capital IQ here...

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