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Sell in May and Go Away – Myth or Reality?

Sell in May and Go Away – Myth or Reality?
To ‘Sell in May and Go Away’ infers that you should sell your stock in May and buy back at some point later in the year.
May 25, 2016 By Simon Herrmann Tags: stocks, Analysis

Many traders have heard of the trading adage which urges investors to ‘Sell in May and Go Away’ to avoid stock market declines, which – apparently – happen after May. But should investors really sell their shares in May and sit on the sideline for the remainder of the year or is the old saying just a myth? Several stock market crashes such as 1929, 1987 or 2008 eventuated in October, so maybe the old saying is right? In 2016 – should you sell in May and walk away? 

Where does ‘Sell in May and Go Away’ originate from?

There are different theories tracing origins of the saying. While many believe that the saying emerged on Wall Street, other sources point to a British heritage with its original form being “Sell in May and go away; come back on St. Leger’s Day.” St. Leger’s Day is one of England’s oldest horseracing classics, typically held in September. Traders would sell their holdings in May to enjoy the Northern Hemisphere summer and return to trading in October.

How can this be employed as an investment strategy?

To ‘Sell in May and Go Away’ infers that you should sell your stock in May and buy back at some point later in the year. It can be regarded as an investment strategy based on seasonal trends. Utilising the saying’s St. Leger’s Day lineage – it effectively suggests investors should only be in the market for half of the year.

A ‘Sell in May’ strategy represents a contrast to common ‘buy and hold’ approaches where investors simply hold their stock throughout the entire year. To have merit, the ‘Sell in May’ approach should be associated with poorer stock market returns over the Northern Hemisphere summer compared with other parts of the year. To test the theory, we have split our calendar into two equal halves at the month of May and considered differences in historical performance of the Dow Jones Industrial Average. Validation of the ‘Sell in May’ philosophy would therefore require the May – October period to yield poorer returns than the November – April half.

More than One Hundred Northern Summers: Dow Jones 1900-2015

To determine whether a ‘Sell in May’ strategy has merit, we have reviewed more than 100 years of data surrounding the Dow Jones Industrial Average. The ‘Sell in May’ period is defined as May 1st and October 31st, returns from which are compared to the other half of the year, November 1st – April 30th.

 

Table 1: Performance comparison for the Dow Jones Industrial Average between 1900  and 2015

 

Whilst both halves of the year are associated with positive returns, there is clear evidence supporting part of the ‘Sell in May’ philosophy. Median returns during the May – October period are substantially lower than the November – April half, and the frequency of positive returns is also lower. This indicates that stock markets have been weaker in the months following May.

Whereas May – October yielded positive returns in six out of ten occasions, November – April saw a ‘win rate’ of seven out of ten. The median return for November – April was 4.2 per cent vs 2.6 per cent for May – October, whilst differences in the average return profiles were even more pronounced.

Case Study: Would 'Sell in May' have worked in the past 10 years?

November – April yielded an average return more than 3 times greater than the May – October period. Over the last ten years – how would this have played out?

In this case study we compare the performance of the two periods between 2006 and 2015. We assume a starting balance of $1000 invested only for the duration of the respective period, being either November – April (“November Period”) or May – October (“May period”). No brokerage costs or dividends have been considered in this example.

 

 

Table 2: Comparison of performance of ‘May period’ vs ‘November period’ between 2006 and 2015.

 

Table 3: 10 year performance of the different periods illustrated in a graph

 

The case study backs up our previous findings as the theoretical closing balance of the May period is essentially flat, while the November period yielded a positive return of 59% or $593.33.

Reality Check of ‘Sell in May and Go Away’

In real life there are a number of factors that may complicate achieving these theoretical returns. Firstly, there are transaction costs, also known as brokerage, associated with every buy or sell order. The ‘Sell in May and Go Away’ strategy requires you to trade more frequently, which results in higher brokerage costs throughout the year. Depending on the cost structure of your broker or the size of your holdings, these costs may partially or entirely offset your gains.

Another issue is capital gains tax which you may be required to pay. In the event you receive more for your shares than you paid for them, you will have made a capital gain and you will need to pay tax on it. The amount of tax you have to pay depends on a number of factors (please talk to an accountant for more details).

The aforementioned data was based off historical data for the Dow Jones Industrial Average, a benchmark index tracking the largest 30 companies in the US. Many clients hold a number of individual stocks rather than an index ETF and each stock may follow a different trajectory throughout the course of a year. The strategy may or may not work for you depending on the composition of your portfolio and exposure to particular sectors or markets. Also it is worth noting that our assumptions are based off historical data, and past performance is not necessarily a reliable indicator for future performance. While the ‘Sell in May and Go Away’ strategy would have worked in the past ten years (see case study above), it may not yield positive benefits in the next ten years. Investors may potentially miss out on returns by being out of the market for half a year.

Furthermore, many Australian companies pay attractive dividends, often twice a year. All data was based on stock price movements and do not include income distributions. If you are only invested for six months you may potentially miss out dividend payments and the associated tax benefits.

Conclusions

Data confirms that the ‘Sell in May and Go Away’ approach has merits as returns during the May – October period were substantially lower than the November – April half in the past 100 years. Thus by carefully following this strategy, investors would have outperformed the market.

However, there are certain implications which may complicate this approach and may dampen returns in a practical setting. Capital gains tax payable on your capital gain is potentially the largest hurdle for an active trading strategy. While an active trading strategy results in higher brokerage costs, gains may partially or entirely be offset by these costs as well. Also, investors have different goals and depending on investment profile, timing, market or sector exposure, this strategy may not work.

 

If you want to find out what to do in the current market conditions, log in to the membership portal or talk to our analysts on 1300 306 308.

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Simon Herrmann Author: Simon Herrmann May 25, 2016

Simon is a financial analyst at independent research firm Wise-owl who wants to change the world by disrupting the cliché approach to investment decision making with convergent thinking. Wise-owl’s goal is plain and simple: Find the best opportunities for our members by following a proven methodology and to create long-term value through high-quality advice, innovation, technology and education. We combine industry experience and the agile mentality of a start-up. Wise-owl is the future of stock market investing.

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