Sell in May and go away, stay away till St Leger's Day

James Ferguson - Tue 10 Aug, 2004

...The 226-year-old Saint Leger horse race, run in mid-September, marks the climax to the flat-racing season. It also gives a clear date for the most famous market adage of em all: Sell in May and go away. Stay away till St. Legers Day....

The 226-year-old Saint Leger horse race, run in mid-September, marks the climax to the flat-racing season. It also gives a clear date for the most famous market adage of ‘em all...

“Sell in May and go away. Stay away till St. Leger’s Day.”

The inference is that there is no point trading in the summer. All the brokers and fund managers will be hanging out on the beach, or attending Wimbledon and Ascot. Volumes will be low and markets more likely to fall. Once the racing season’s over, the City boys get back to their desks...and the stock market picks up.

Nowadays, a large section of the City considers this complete nonsense. There’s a “harder working culture to the City” than there used to be, insists Hilary Cook of Barclays Stockbrokers. Selling in May and buying back in September is an “eccentric form of market timing”, agreed David Kuo on Motleyfool recently. It is, he reckoned, “no more accurate than flipping a coin”. But they’re both wrong. On average, the stock market actually loses 1.8% of its value each summer. Compounded over a couple of decades, that makes for a tidy sum...an overall loss of 30%.

In fact, following the old saying since 1984 would have returned 55% more than a simple buy-and-hold strategy, according to research by AdvFn.com. Going still further back, economist Ben Jacobsen has found that the ‘sell in May’ rule has worked for UK shares ever since 1964.

Quite simply, January and April are good months to be invested. June and September, on the otherhand, aren’t. They show average losses of 0.2% and 0.9%.

Overall, in the last 40-odd years, British investors have been 50% more likely to suffer a down month between May and October than between November and April. Not only that, but the average gain in August - the best-performing summer month - wasn’t materially better than March, the worst-performing of the winter months.

Still, “Sell in May and go away” isn’t quite perfect. It suggests buying back in September...but October’s usually rubbish too! This is the month the markets crashed in 1987, 1997, 1998, and most famously in 1929. An Investors Chronicle study shows that October returns averaged just 0.6% over the last four decades.

The element of truth in the old saying also applies to foreign markets, too. A study by analysts Roy Young and Phil Kennedy at Mitsubishi Securities has shown that this same seasonality affects the Tokyo market. They tracked the average 30-day returns of the TOPIX index since 1970, and found that from June to November, market returns have been almost exclusively negative. However, from December through May, they have been almost entirely positive.

Even the aggressively professional Americans suffer seasonal weakness!

** Since 1950, some 98% of the gain in the Dow has come between November and April.

** In six of the last 17 years, the Dow’s low of the year was in October (arguably, it would have been seven times if September 11 hadn’t rushed the Dow to a late September low in 2001).

** There were also big sell-offs, though not quite to new lows for the year, in October 1997 and 1999.

No wonder American traders prefer to wait until Halloween before they buy back into their markets. There’s less seasonality in the UK government bond market, but it’s still there. The Investors Chronicle recently noted that since 1969, gilt prices have fallen, on average, by 0.08% between 30 April and 31 October. The rest of the year, they’ve actually risen by an average of 0.44%.

But if the old brokers’ saying really does work, why? The Investor’s Chronicle recently noted two commonly accepted factors for the summer’s poor returns. The first is that the winter tends to create economic risks. Since 1965, real GDP has fallen by an average of 4.9% in the first quarter of each year, having risen strongly in the previous quarter. This higher risk must be rewarded with higher returns in the spring - and it is. The second reason, however, is purely psychological...

In March and April, the lighter evenings cheer us up and we feel like taking risks. So we buy shares, pushing the market up in the process. Then, from such high levels future returns are poor. Hence lacklustre summer returns. Equally, in September and October we start to feel “anxious and depressed”, reports the Chronicle, so we are loath to buy shares. The market falls, so that by the end of October shares are cheap and subsequent returns good.

But the first argument, as the Investors Chronicle itself points out, isn’t supported by the facts. Australia’s GDP does badly in the first quarter too. Yet Australian equities still go on to perform better during their own autumn - the UK’s summer - contradicting the second, psychological argument. Indeed, the serious seasonal investor should consider moving into southern hemisphere stocks for the summer, rather than selling in May and putting all funds into cash.

Since 1973, Australian stocks have underperformed UK shares by 4.5% from November to April...but outperformed by more than 3% between May and October. Any investor could have compounded their UK gains by switching Down Under just before the FTSE began its annual summer slowdown.

Meanwhile, a more likely reason for selling the major markets of the Northern Hemisphere in May - New York, London, Frankfurt and Tokyo - is that June and July tend to be relaxing months for most of us. Traded volumes plummet. Then, come the end of the summer, everyone starts worrying. There are elections to fuss about every few years, and firms that aren’t going to hit their forecasts start to issue warnings. Peter Siris also notes that investors worry “Christmas sales won’t come and mutual funds do tax-loss selling. That’s why early [autumn] is even worse than summer.”

The counter-point to the autumn blues is that September/October sell-offs create buying opportunities in November and December. In New York, for instance, from January through to March, markets are buoyed by an influx of new money from corporate bonuses and pension plans, as well as companies spending their year-end surpluses buying their own stock to pay for employee stock options. Hence the good winter.

In fact, equity-market seasonality seems to be a factor of all equity markets. Whether it is worth trading, though, depends as much on your dealing costs and tax situation as anything else. But it certainly suggests the market may not be quite as efficient as the academics would have us believe.  


Regards,

James Ferguson
for the Daily Reckoning

P.S. Of course, one reason why many commentators think selling in May and buying back in October is not a great idea, is because your dealing costs can soon add up, neutralising any gains. Plus, you have to forgo any dividends paid on your shares during the summer.

But neither of these factors should be considered an impediment in today’s environment. With interest rates on the rise, any forgone dividend payments will be made up by the interest paid on a good account. Northern Rock is paying 5.21% on its Tracker Online account, for example. And for those who shop around, share dealing costs are really very low.