There is an old adage in some investing circles that one of the best market-timing strategy around is “Sell In May And Go Away”. In fact, in the UK it is even more specific than that, suggesting that one should “Sell In May And Go Away. Stay Away Till St Leger Day”. For those who don’t know, the St Leger is actually a horse race run in Doncaster, England in September of each year (this year’s race will be on 11th September). I was recently asked about this approach at a client meeting and my initial reaction was that market timing strategies such as this are doomed to failure, with the only sensible approach being one of strategic long-term investing. Since we are indeed still in May I thought I would take a more detailed look at the merits and drawbacks of this strategy.
My general view on this type of approach is that you would probably be wiser to have a flutter on the outcome of the St Leger than to follow this piece of advice. The argument runs that over the long-term that the weakest months for the equity markets have tended to fall between May and September annually. This is something that is typically attributed to market seasonality – in other words the market behaves differently according to varying seasonal trends. There are many theories behind this, the most plausible one being that the summer months typically see thin markets, with light volumes as traders take their annual vacations. This can cause the markets to drift lower, and react in a more volatile fashion to negative newsflow.
What is really rather interesting is that the theory doesn’t appear to hold water over the long term. An analysis of the benchmark U.S. S&P 500 index from 1928 to the present shows that the market only declined 30% of the time between May and September over the last 82 years. Conversely, from September to May it was in negative territory 38% of the time over the same time period. In aggregate, it has fallen one-third of the time and risen two-thirds of the time. In other words, from a purely directional perspective, the market has actually performed better between May and September over the longer-term time horizon.
Of course, you could argue that this only considers market direction bias and not the magnitude of market volatility in each of these periods. However, once again the strategic investor would beat the tactical investor in this analysis. Those who invested $1,000 in 1928 and remained fully invested would have seen their investment grow to $81,965 by the end of 2009 (a whopping 8,070% total return). Conversely, the investor who sold their positions in May of each year and reinvested in September would only have seen their initial investment grow to $12,311 (or 1,131% growth) over that entire period.
One interesting point to note is that this sort of tactical market timing strategy appears to have failed miserably at times of extreme market volatility. For example, during the Great Depression, most of the significant market losses were seen during the September – May period. Between September 11th 1931 and May 1st 1932, the S&P 500 declined by an enormous 54%. Similarly during the tech bubble and crash of the early 2000s, the market fell by 14% between September 2000 and May 2001. Lastly, during the recent credit crisis, the September 2008 to May 2009 period saw the S&P fall by 37%. In other words, the worst of the losses actually occurred precisely at the time when the “Sell in May-ers” (as I shall call them) would suggest you should be fully invested!
There may be an argument that the strategy works better under more normal market conditions. Proponents would doubtless strip out years where the market exhibited extreme volatility, and demonstrate that it is indeed a sensible approach in a “normal” year. However, given the market conditions we have witnessed recently, it is proving somewhat difficult to predict when such a “normal” year will materialize. Indeed, while markets have seen some support since the beginning of 2010, volatility is picking up once again amid concerns over the sovereign debt of countries identified as the PIIGS (Portugal, Ireland, Italy, Greece and Spain). At the same time, investors are fretting over the sizeable debt taken on by global governments during the credit crisis, their ability to finance these obligations in the long-term, and the impact on the global economy of such financing needs. Of course, the market is down by -4.2% so far in May at the time of writing, so doubtless this will give the “Sell In May-ers” some ammunition for their theory.
Nonetheless, against a longer term backdrop tactical market timing strategies seem doomed to failure and are probably best left to macro hedge fund managers employing complex algorithmic models to predict short-term market trends. Individual investors will likely see greater rewards from strategic investment decisions surrounding asset allocation and risk tolerance. But on to more important matters – what about my pick for the St Leger? Well, if seasonal trends are anything to go by, I would note that famed Italian jockey Frankie Dettori has won this race on three of the last five outings. So those who are interested in placing a bet might be well served in considering Frankie and his mount in September’s race!
The views expressed are the opinions of the writers and may differ from the views of Royal Bank of Canada or its affiliates. Gareth Pulman is Senior Portfolio Manager with RBC Wealth Management.