Sunday, April 5, 2015

“Sell in May”
But Maybe Not This Time


After reading last week’s post, one of our perceptive readers asked about selling, specifically why not follow the old saying and “Sell in May and Go Away?” The decision whether to pursue this course should depend upon an understanding of the historical construct, the data, and the decision process.


Like with much of market knowledge this saying may have come from the City of London. (This square mile in London is where much of Britain’s financial transactions take place.) For centuries the gentry left their London homes to go to Bath or other resorts, which often had casino gambling as distinct from betting on the securities markets. This pattern was also followed in the US, pre air-conditioning, where many of the trading centers in the South were deemed to be unbearably hot in the late spring and summer.

Dow Jones Industrial Average Data

Air conditioning was already an important economic and personal comfort factor by 1985, some thirty years ago. If one looked at the DJIA performance since the first quarter of 1985, an interesting pattern appears in terms of quarterly performance. The first quarters’ average gain over the 30 years was +3.18%, followed by +2.92% average for the second quarters, -0.21% for the third quarters, and +4.44% for the fourth quarters.

My specific focus

The data does show there is a clear seasonal pattern but hardly enough of a trading difference to bear transaction costs, tax impacts, and the bother of trading. However, as both a professional money manager and an investor, I screen the data differently. Over the 30 years the annual average gain was 10.47% per year. Using 10% as a primary filter I looked for the exceptional quarter that produced moves that were equal to an annual average. In the first quarters there were 5 quarters of 10% or more gains and only one with a 10% loss. In the second quarters the ratio of 10% moves was 4 to the upside and 1 to the downside. Interestingly in the third quarters the ratio was 3 on the plus side and 5 negative results followed by a recovery in the fourth quarters of 6 positive and 2 negative. Therefore, if one could avoid owning stocks in the third quarters it would give support to the old saw.

However, there is another observation of the data and a different conclusion. As regular readers of these posts may know, I have speculated that we are due for a 20% or more gain within a year. My analysis shows that over this period we have enjoyed 20% or more annual gains 10 times and only one 10% loser in a year. Since the turn of this century or half of the period studied we have had only 2 years of 20% or more gains and both of these were more than +25%. In addition, the first quarter of 2015 produced a -0.26% move, thus there does not seem that there is much that the DJIA needs to correct by producing a 10% or more decline.

Decision process

I will not deny that based on historical odds investors should be preparing to reduce their equity commitments. This would fit under the general use of the portfolio manager’s guidelines which probably work around two thirds of the time. Often investors develop Investment Policy Statements (IPS) which are expected to guide the portfolio manage most of the time. Going outside of the IPS is permitted for sound reasons and could conceivably happen once every four years. (I would suggest that 2015 could be such a year.) Stricter controls of investments are found in rules, often built into contracts which could be abrogated under unusual circumstances. This could happen once every ten years. However, I don’t believe this is yet the case.  

Additional research elements

The Barron’s Confidence Index is pointing toward a more favorable stock market based on the spread of yields between high and intermediate quality bonds. Some competent conservative investors are advocating buying into the Russian stock market in their bargain hunting. One would only do this if one thought the base US and other major developed markets would remain ebullient.

The other drive that I perceive is the accelerating march of technology. Technology changes not only how we do things but also how we think. Professor Harry Atwater recently addressed a meeting of the East Coast Caltech Associates, where he spoke on “The Future of Renewable Energy.” His theme seems very bright and is based on an increase in solar battery efficiency.

While this may be debatable, he did quote a sage, saying that the Stone Age did not end because we ran out of rocks, but because humans discovered bronze tools. This was a wake-up call to me.  Our memory driven decision process should be overridden when new tools become usable. Thus, I need to redouble my efforts to understand the new tools that are coming on the market that question our past guidelines.  

Consequently,  I am not going to sell in May and go away.
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