Sell in May and Go Away—with a Twist

05/07/2007 12:00 am EST

Focus:

Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, chief investment strategist at Standard & Poor's, suggests a new way to play the seasonal ebbs and flows of the stock market.

The Standard & Poor's 500 index just eclipsed the 1,500 [and] market sages are now talking about overtaking the S&P 500's old high of 1527 in the next two months. At this rate, the S&P 500 could be up 17% for the full year.

But many investors must be wondering if the recent market advance is sustainable. It's no wonder investors are considering the old Wall Street adage: "Sell in May then walk away."

S&P Equity Strategy believes investors would be wise to heed the advice, but in a slightly altered fashion. Since 1945, the S&P 500 posted an average price gain of 7.1% during the November through April (N-A) period, versus a rise of only 1.6% from May through October (M-O), implying that greater profits could be made elsewhere.

We think there are several reasons for this pronounced seasonal strength and weakness. History shows that the S&P 500 has posted its weakest three-month average performance in the third quarter, as investors may be focusing more on their tans than their portfolios.

What's more, October is historically a month in which the market establishes a bottom, so the S&P 500 enters November at a fairly low level compared with other months. This gives the N-A period the advantage of starting at a lower base. The above-average strength in the N-A stretch may be aided by large cash infusions into the market: IRA and 401(k) contributions, as well as the investment of bonuses and tax refunds.

N-A also has been fairly consistent in recording advances that have been above the long-term average. Since the average M-O return is little different than holding cash, why incur the transaction cost and tax consequence?

Here's one idea. Since 1990, we find that while the cyclical sectors like financials, industrials, and materials (and consumer discretionary and information technology to a lesser extent) typically beat the market during N-A, the consumer staples and health care groups-the defensive safe havens-did the best from M-O.

Had an investor owned the S&P 500 from N-A, then rotated into the S&P 500 consumer staples or health care sectors from M-O, and then rotated back into the S&P 500 from N-A, [he or she] would have seen their annual return rise from the 9.2% recorded for the S&P 500 to 12.7% for consumer staples and 13.0% for health care.

In 2006, while the S&P 500 rose 5.1% from M-O, the S&P consumer staples index gained 8.8% and the S&P 500 health care index increased 7.8%. The old adage appears to have some merit. In fact, S&P's Equity Strategy Group recommends overweighting the S&P 500 consumer staples, financials, and health care sectors.

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