Swedroe: Why ‘Sell In May’ Doesn’t Work

November 30, 2018

The “sell in May and go away” strategy is one of the Wall Street myths that persists despite the evidence that shows there is no foundation for believing it. My colleague at Buckingham Strategic Wealth, Dan Campbell, takes a deep dive into the strategy and shines on it the light of truth.

October was a rough month for equities: Morningstar data show the S&P 500 Index fell 6.8% and, according to Cboe Global Markets data, the VIX, a commonly used measure of fear in the marketplace, rose from 12.12 to 21.23, a 75% increase!

October’s poor performance has rekindled questions about whether the winning strategy really is to “sell in May and go away.”

Despite the large drawdown in October, the S&P 500 Index returned 3.4% from May through October this year, outperforming riskless one-month Treasury bills notably (which returned 0.9%).

Number Crunching

Let’s look at the historical evidence. Using Ken French’s data library, since 1926, it is true that stocks have provided greater returns from November through April than they have from May through October. That may be the source of the myth.

The average premium of the S&P 500 Index over one-month Treasury bills averaged 8.4 percentage points per year over the entire period. And the average premium of the portfolio from November through April was 5.7% compared to just 2.5% for the May through October portfolio. In other words, the equity risk premium from November through April has been more than twice the premium from May through October.

Furthermore, the premium was negative more frequently for the May through October portfolio, with 34% of the six-month periods having a negative result, compared with 27% of the six-month periods for the November through April portfolios.

From 1926 through 2017, the S&P 500 Index returned 10.2% per year. Importantly, the May through October portfolio had a positive equity risk premium of 2.5% per year, which means the portfolio still outperformed Treasury bills, on average. In fact, a strategy that invested in the S&P 500 Index from November through April, and then invested in riskless one-month Treasury bills from May through October, would have returned 8.3% per year from 1926 to 2017, underperforming the S&P 500 Index by 1.9 percentage points per annum.

That’s even before considering any transactions costs, let alone the impact of taxes (you’d be converting what would otherwise be long-term capital gains into short-term capital gains, which are taxed at the same rate as ordinary income).

Long Time Since Selling In May Worked Out

What’s perhaps most interesting is that the last year the “sell in May” portfolio outperformed the consistently invested portfolio was 2011. Yet you can be sure that come next May, the financial media will be raising the myth once again.

Investors should expect the S&P 500 Index to underperform Treasury bills over some six-month (or any investment horizon) periods, because the equity risk premium is a reward for bearing the risk of being invested in stocks. A large part of that risk is the chance the stocks will underperform riskless investments.

As mentioned earlier, from 1926 through 2017, the annual average market risk premium was 8.4% per year. The annual volatility of that premium, again, according to Ken French’s data, was 20.4%. The result is that, in two-thirds of the years, we should expect that the equity risk premium would be between -11.9% and 28.9% (one standard deviation). We should also expect Treasury bills to outperform equities in about 34% of years.

So, what about the six-month period from May through October? The story is the same—we should expect an average premium over any six-month period of roughly 4.3%, and the volatility of the premium of roughly 14.4%. The result is that we should expect the equity risk premium to be negative over a six-month period roughly 38% of the time.

Understanding Risk & Return

The most basic tenet of finance is that there should be a positive relationship between risk and expected return. To believe that stocks should produce lower returns than Treasury bills from May through October, you have to believe that stocks are less risky during those months—a nonsensical argument.

Unfortunately, like many myths, this one seems hard to kill off. And you can bet that, next May, the financial media will resurrect it once again, because dire warnings attract attention.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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