Monday marked the first trading day of May.
With that flip of the calendar page, investors are wondering whether or not they should follow the old adage: “Sell in May and go away.”
Like so many investing adages, there’s an element of truth to this one… and many caveats. Ultimately, your decision to follow or ignore this market-timing strategy depends on how you invest and protect capital.
Buy-and-hold investors might do well to heed the advice.
But for other investors, particularly those of us who employ active and statistically sound strategies, the “sell in May” advice isn’t all that helpful. In fact, following the advice blindly would actually undermine my strategy’s long-term return potential.
Let me walk you through a few research studies that show why there’s nothing to fear (“but fear itself,” perhaps) in May.
We’ll start with a look at this chart:
Looking at the percentage price returns of rolling six-month periods, you can see why the idea of “sell in May” looks like such a good one. The worst six-month period is May through October, which, since 1979, has netted a positive return of just 2%. Meanwhile, the best six-month period is November through April, which has produced an average return of 10.5%.
So, if you aim to hold stocks for one six-month block of the year, and remain in cash the other six months, then you’re best to buy stocks in November and sell them at the end of April.
Doing this, you’d miss out on the average 2% return typically produced between May and October, but you’d also avoid the volatility of that period. For you, that may be a favorable trade-off.
But, in my eyes, this is where the value of “sell in May” ends.
If you’re an active investor — like those of us who use proven strategies such as Cycle 9 Alert to time the market over shorter time horizons — then you need to dig a bit deeper to know what to expect in May.
In reality, there’s nothing particularly scary about stock returns in May.
Here’s a chart that shows the results of investing $10,000 in each of the nine sector ETFs we track in Cycle 9 Alert, plus $10,000 in the S&P 500 (SPY), at the beginning of each calendar month and selling 22 days later:
While some months are clearly stronger than others on a seasonal basis, May falls in the middle of the pack and still posts positive returns, on average.
So it’s not the awful month for stocks it’s made out to be. Rather, June is more troublesome for buy-and-hold investors.
In reality, May can actually be a lucrative month for active strategies that rely on momentum and volatility expansion to generate outsized returns. That’s because the month has historically been the third-most volatile month of the year. And that’s a good thing for active investors.
In fact, my Cycle 9 Alert strategy is specifically designed to benefit from volatility.
Volatility works for us in two ways:
Firstly, it creates new opportunities to get in and out of sectors that are outperforming and underperforming. And since we target short holding periods, we’re nimble enough to adjust positions as volatility spurs new market trends.
Secondly, we buy stock options. That means when volatility expands — all other things being equal — our positions became more and more valuable. So we look for an increase in volatility (not a decrease) because that gives an “energy boost” to our positions.
All this means that the expression “sell in May” isn’t useful for active strategies, like Cycle 9 Alert.
Even if the broad market tends to be weak, my Cycle 9 Alert strategy is still able to find profitable sector trends in May and throughout the summer.
Typically, sectors that are considered “defensive” outperform in May. And two sectors in particular — consumer staples (XLP) and health care (XLV) — are often the best sectors to own during this seasonal soft spot.
Those sectors aren’t “buys” just yet… but they could be as the summer progresses. If investors’ nerves begin to get the best of them, we should see some great opportunities in defensive market trends over the next few months.
Make sure you’re on my Cycle 9 Alert subscriber list to get access to all of our best plays.
To good profits,
Adam O’Dell, CMT
Chief Investment Strategist, Dent Research