Election Could End the Summer Sell-Off

06/27/2012 11:45 am EST

Focus: MARKETS

Eric Vermulm, CFA

Senior Portfolio Manager, Stack Financial Management

While "Sell in May…" is a real phenomenon, says Eric Vermulm, markets do rise during the summer more often than not, especially in an election year.

Eric, the oldsong Wall Street is always Sell in May and go away and head out to the Hamptons and relax and forget about the summer, and for the past two years, I guess,that’s been kind of true. It would have been a good idea. Is it still like this, this year?

Well, it’s definitely true that in the market, the winter months—November through April—is when we see most of our gains.

We’ve done a couple studies, what we call "The Tale of Two Investors." If you invested since 1960 only from November through April, your investment would have grown 40-fold. Whereas if you were a summertime investor—May through September—then sit in cash through the winter time, your investment would have doubled. A little bit more than doubled, but you can see not nearly the 40-fold that you would have gotten in the wintertime.

Yeah, it’s a significant difference.

It definitely is, and it leads to this adage "Sell in May and go away," which does work at times. But if we look at the numbers a little closer—dig into the numbers a little bit—what we have seen is that about 63% of the time, the market still goes up in the summer months.

When we see those big drop-offs in the market, it is usually in an already-identified bear market—a summer like 2008, where we were already pretty much in a bear market.That was a very rough, rough time for the marketplace. But normally, like I said, about 63% of the time, the market does go up in the summer months.

Add onto that the fact that we are in the fourth year of an election cycle. Typically, election years are pretty good years for the market. They go up about 7%. If we look at the summer months from an election year, the probability that the market will rise jumps from 63% up to 80% in those summer months.

So we see a lot better probability in the summer months of an election year that the market is going to go up. And typically, it goes up about 5.3% historically, since 1928, when we measured the data. Even better than that, it typically goes up later in the year. We’re already in May, and so we’re in the summer months. So we’re getting that 5.3% in the third quarter and the fourth quarter of the year historically.

From a risk-management perspective, what we see is there has only been one double-digit drop in an election year during the summer months. That came in the most recent election, 2008. But historically, the market doesn’t drop that much during the summer months of an election year. We’ve never had a double-digit drop outside of 2008.

So the probabilities are definitely in our favor, along with the fact that we’re not seeing any bear-market warning flags right now. We’re not in the middle of an already-identified bear market.

So this is pretty much just the traders wanting to get out of the city during the hot months in New York.

It can be.

Is volume affected during the summer? Does volume actually go down?

Volume typically does go down during the summer.

But it’s been a fairly light-volume year to begin with.

It has. And this whole bull market since the beginning of 2009, volume has been criticized as some reason that this bull market will not be able to continue. Yet here we are, three years into it, and volume just has not been that good of indicator up to this point.

So I think it is that those traders might want out of the city for the summer months. But if we do start to get warning flags in the marketplace— if we do start to see deterioration in technical and fundamental data— this summertime isn’t a time you want to hang around the marketplace, because that’s when you see the sell in May and go away. You can really get beat up during the summer months during an identified bear market.

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