This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Mack Courter, founder of Courter Financial in Bellefonte, Pennsylvania.
In April of every year, we see dozens of articles urging us to sell in May and go away. In its basic form, you sell stocks on May 1, and you buy them back on Nov. 1. The strategy is credited to the respected Yale Hirsch of the Stock Trader’s Almanac, who began covering it in 1986.
Hirsch observed that stocks typically do much better in the six months between November and April (strong period) than they do between May and October (weak period). But is this really an effective strategy?
At first blush, it seems to have merit. Most stock market crashes occur between May and the end of October.
The flash crash, in which the Dow Jones industrial average surrendered almost 1,000 points in minutes, occurred in May 2010. During the Great Recession of 2008, the S&P 500 plunged more than 16% in October 2008. Black Monday, the largest stock market crash in U.S. history, happened in October 1987. The Great Depression was ushered in by the stock market crash on Black Tuesday in 1929, also in October.
Comparing The Strong vs. The Weak Period
I recently examined the S&P 500 monthly returns using Ibbotson Associates data through the end of 1998, and the SPDR S&P 500 ETF (SPY) since then. The S&P definitely performs better November through April than it does May through October. From May 1972 through October 2016, there have been 45 May through October periods and 44 November through April periods.
You can see in Exhibit 1 that there have been more positive periods in the strong six months as opposed to the weak six months:
The differences are starker when comparing the average return for the S&P 500 in the strong periods compared to the weak ones in Exhibit 2:
During November through April, the S&P 500 has returned 8.05% on average. But during May through October, the index has returned only 2.94%.
But, you will point out, even though the average return is not as good during the weaker six months, it is still positive. So if you sit on the sidelines from May through October, it appears you’ve lost almost 3%.
Buy & Hold vs. Sell In May & Go Away
I decided to compare simply buying and holding the S&P 500 with selling in May and going away. For the Buy and Hold portfolio, I simply calculated the monthly returns of the S&P 500 Total Return Index as provided by Ibbotson Associates through 1998 and SPY, including dividends thereafter.
For the Sell in May portfolio, the S&P 500 is bought on the close of the last trading day in October, and sold at the close on the last trading day in April. Between May and October, the portfolio stayed in cash, and earned nothing.
When I crunched the numbers, here’s what I found: As detailed in Exhibit 3, Buying and Holding significantly outperforms Selling in May and Going to Cash on an absolute basis. But, not surprisingly, selling in May significantly reduces risk as measured by standard deviation. In addition, its Sharpe ratio—which compares the portfolio’s excess return to its standard deviation—is higher.
We now have a dilemma. If you’re like me, you want the higher return of the Buy and Hold portfolio, but you also want the lower risk of the Sell in May portfolio. Tweaking the basic strategy is the next logical step.
Sell In May & Go To Bonds
The next safest alternative to cash is bonds, specifically intermediate Treasuries. In Exhibit 3 below, I compare the previous two portfolios with a portfolio that invests in bonds during May through October. I used data from Ibbotson Associates until the end of 2002. Beginning in 2003, the iShares 7-10 year Treasury Bond ETF (IEF) is used.
Selling in May and Going to Bonds beats both Buy and Hold and Selling in May and Going to Cash on an absolute basis. Risk is lower than Buy and Hold, but higher than Selling and Going to Cash. Its Sharpe ratio is much better than either of the other strategies. Overall, it’s an intriguing proposition.
But with the Fed beginning to raise interest rates, some may get nervous having a higher exposure to bonds for half the year.
Sell In May & Go To Consumer Staples & Utilities
Sam Stovall, chief investment strategist of U.S. equity at CFRA, quoted in the article, “Sell in May and Go … Where?”, has recommended investing in the S&P 500 during the strong months. But during the weak months, he suggests investing in defensive stocks, specifically in the consumer staples and health care sectors of the market.
I researched this strategy, but with a twist. While I keep consumer staples in the portfolio, I use utilities instead of health care. I feel utility stocks are more defensive than health care stocks. Data is drawn from Fama-French until 1999, when the SPDR Consumer Staples ETF (XLP) and the SPDR Utilities ETF (XLU) are used. Both sectors are weighted equally.
While this strategy performs better on an absolute basis than the first two strategies, it underperforms the third strategy. Its standard deviation is also not much better than Buy and Hold.
I crunched the numbers once more for one more alternate portfolio. This one is much more diversified, and therefore more real-world.
Diversified Sell In May Portfolio
This portfolio allocates 50% to the S&P 500, 25% to small-cap value stocks and 25% to small-cap growth stocks during the strong period. I used Fama-French data through Dec. 31, 2000. Thereafter, I use the iShares Russell 2000 Value ETF (IWN) and the iShares Russell 2000 Growth ETF (IWO). During the weak period, the portfolio allocates 50% to intermediate Treasury bonds, 25% to consumer staples stocks and 25% to utilities stocks, using the same indices and ETFs as described earlier.
|Sell In May Strategies vs. Buy & Hold|
|1973-2016||Geometric Mean||Std Dev||Sharpe Ratio||$1 Growth|
|Buy & Hold||10.10%||17.60%||0.46||$70|
|Sell in May & Go to Cash||7.60%||10.90%||0.51||$25|
|Sell in May & Go to Bonds||13.10%||12.70%||0.88||$228|
|Sell in May & Go to Cons Staples/Utilities||12.50%||17.10%||0.61||$179|
|Diversified Sell in May||15.30%||15.40%||0.86||$531|
The results speak for themselves. This strategy outperforms all the others on an absolute basis. It also outperforms all strategies except Sell in May and Go to Bonds on a risk-adjusted basis. And it accomplishes this feat with less risk than buying and holding the S&P 500.
So, should you sell in May and go away? It depends where you go.
At the time of writing, some of the authors' clients held IEF, but the author held no positions in the securities mentioned. Mack Courter, CFP® is founder of Courter Financial in Bellefonte, Pennsylvania. Disclaimer: This article is for informational purposes only, and is not meant as specific investment advice. Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is not a guarantee of future results. You can reach Courter at [email protected].