Don’t Sell…Just Rotate

06/22/2012 9:45 am EST

Focus: STRATEGIES

Sam Stovall

Chief Investment Strategist, CFRA Research

S&P Capital IQ Equity Research’s Sam Stovall suggests investors not go away in May, but instead switch into specific sectors that are likely to do better if the market keeps falling.

Sell in May. Is it still valid in 2012? We’re here with Sam Stovall, who is going to tell us whether sell in May and go away is the way to go or whether there’s something different this year.

Well, I never think that you really should go away. The reason is that while the market certainly does much better from November through April, gaining close to 7% versus an advance of only 1% from May through October since World War II, the 1% gain annualized is well better than what you get in cash.

Plus, there have been several times in which the market has done pretty well in May through October. What I have found, however, is that by rotating into the consumer staples and health care sectors so you’re still sticking with stocks—but you are becoming definitely more defensive from May through October—you would have added 400 basis points or four percentage points per year to your overall return.

Instead of getting 6.8% since 1990 for the S&P alone, you would have gotten 10.8% by being in the S&P from November through April, but being in the S&P health care and consumer stocks from May through October and then every six months rotating either to the full market or back to the defensive areas.

Wow, that’s a fascinating statistic. I guess the fact is that these are the sectors where it’s better to park your money. There’s going to be less volatility there even if there is less volume during the summertime.

That’s right. Well, first off, you also have to realize that history is a guide; it’s never gospel. There’s no guarantee it will continue to work.

Long-only investment managers really can’t be in cash. They can put some of the money in cash for redemption purposes. What they do is if they believe that stock prices are vulnerable, they tend to hide out in the defensive areas, in particular consumer staples and health care.

It’s not because people like to get hip replacements in August, it’s simply because you want to engage in capital preservation whenever the prospects that the market could be declining are elevated. That’s what investors do, stay with stocks, because if the market fools a lot of the bears and rises in the May through October period, then a rising tide lifts all boats and the staples and health care stocks will also do better than they would than if you had moved directly into cash.

And I would assume the corollary is true where if things go bad during the summer, those are two very strong sectors that are going to feel it less in the short term than other sectors might if you’re in technology or something.

Exactly. On average, all sectors decline during severe corrections, bear markets, etc.; but the defensive ones tend to lose less than the overall market, mainly because the demand for the products and services remains fairly static.

Whether times are good or bad, you still need to eat, smoke, and drink, and if you overdo it you go to the doctor. Hence, staples and health care do relatively well.

The key is capital preservation. Remember that a 20% decline requires a 25% advance to get back to break even, but a 50% decline requires a 100% advance to break even. The less you lose, the less you have to make up.

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