Share Market Adages – Shortcut to Success or Fools Gold? Part I
Today Raj Padarath gives his personal take on the old Share Market Adage ‘Sell in May and go away’.
As we move through life we are exposed to various quotes and sayings of collected wisdom. Often, we accept these as true because they are stated as fact by people who ought to know what they are talking about. So as infants we accept that red cordial makes us hyperactive, because our parents say so. When we reach school age we learn from our teachers that greed, in fact, is not good, and not sharing the good toys will make us unpopular with the other children.
So it’s hardly surprising that when we reach the age at which we begin to invest our money in the share market that we continue to accept advice from those who surely know what they’re talking about. Two such adages are the ‘sell in May and go away’ saying and the theory of the post-election share market bounce. We thought it would be worth investigating both here.
Sell in May and Go Away
The theory is more or less explained in its title, though more colourful names such as ‘The Halloween Indicator’ are also thrown about at times. The hypothesis is that the 6 months of the year beginning in May are the best time to rotate out of all stock holdings, because it substantially underperforms the November to April half of the year.
The reasons for this are varied, but the conventional wisdom states that factors such as the summer months and the associated long vacation times as well as a lower data flow (in the absence of holidays sales and subdued business activity) lead to a lower volume of trades and investment through these months. As with any good maxim one can find evidence to support the cause, with the Stock Traders Almanac showing that since the 1950’s the Dow Jones Industrial Average has had a return of 0.3% per year in the 6 months starting May, while the winter months have returned an average of 7.5%. The graphic above shows this phenomenon, with the compounded return of the November – April portfolio an impressive 7,543% and the May to October period languishing at a mere 3% return.
And Now for Deep Breath
Before you rush out to rebalance your entire portfolio however, the chart above has to be put into context. The graph fails to include a line which represents what an investor would have returned on his share portfolio had he merely held his stocks rather than bought and sold like a trader on a 1920’s trading room floor. The return on a portfolio of long-term buy and hold stock picks would have outperformed both 6 month breakdowns by a substantial margin.
It also pays to look at more recent history. In the past 4 years the FTSE 100 has declined only once in the May half of the year, albeit by a portfolio rattling 15% in 2011. In each of the other four years there have been modest gains booked by the index. The same mixed lead is true of the S&P 500 index in the United States, with the ledger split 50:50 between gain and loss in this period. The poor performance in 2011 was the result of the perceived upcoming implosion of the Eurozone brought on by fears of Greek, Spanish, Italian and Irish budget defaults all occurring at the same time.
This brings us to the next and perhaps most obvious point. Modern stock markets are irrational conglomerations of millions of investors and billions of dollars interconnected around the globe. And this complex web is unquestionably affected by geopolitical as well as financial news. Witness the recent turmoil in Syria and its effect on equities as proof. The only predictable thing therefore, is unpredictability, and global events do not follow the neat 6-month breakdowns that the theory requires.
This strategy also fails to take into account the implications of tax, not to mention the time and effort involved in portfolio liquidation and re-creation every 6 months. Empirical research shows that if your goals are long-term, that a buy and hold strategy outperforms the seasonal switch by a substantial margin, allowing the payment of dividends and reinvestment without tax liability eroding gains.
What is the best evidence of the success and advantages of picking stocks and sticking with them? The world’s best-known stock market billionaire, Warren Buffett, made his fortune that way.
Are there any Share Market Adages that you swear by?
Keep a look out for Part 2 of this series where we’ll discuss the ‘post-election share market bounce’.