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Sell in May? Think Rotate

12 May 2013 in Trading Ideas

Next to baseball’s Opening Day, one of the surest signs of spring is the surge of financial media opinion debating whether the waning of April means it’s time to sell stocks.

This is most commonly seen in question form: Should you “sell in May, and go away?”

For the uninitiated, the above adage comes from the theory that, on average, stocks historically underperform during a period that begins in May and ends in October.

According to a Stock Trader’s Almanac survey of the market from 1945 through 2010, the S&P 500 posted an average gain of 6.1% (excluding dividends) in the period of November 1 through April 30, but only a 1.3% rise in May through October.1

What’s more, this seasonal outperformance has shown a 78% “frequency of advance,” meaning that it has happened about three of every four years.

Turning that history into an action plan, investors expecting the seasonal outperformance to continue over a number of years could decide only to be in stocks during the “good” months, then go into cash for the underperforming half of the year.

But here’s another thought, one that forms the thesis behind our new Sell In May? motif: It may serve investors more to embrace the idea of a sector-rotation rather than a departure from the market altogether for six months of every year.

A couple of years ago, a study by Standard & Poor’s Chief Investment Strategist, Sam Stovall, showed that during a 21-year period ending in 2011, had you invested equally across the S&P’s five cyclical sectors (consumer discretionary, financials, industrials, materials and information technology) from November to April, then moved into 50-50 holdings of the defensive consumer staples and health care sectors; you could have enjoyed a compound annual growth rate of 15.4% and beaten the S&P 500 in 16 of those 21 years.1

Our Sell In May? motif employs a similar approach. The idea would involve buying stocks of companies in cyclical sectors during the historical outperforming season, then rotating into stocks in defensive sectors beginning in May.

For short-term investors, this motif may not be your cup of tea. Even ardent fans of this theory are forced to admit that it hasn’t worked 25% of the time, and, naturally there’s no guarantee that it ever will again. Further, you assume the tax consequences and transaction fees associated with this type of trading activity.

However, longer-term investors may favor this sector-rotation approach instead of sitting on the sidelines for six months of every year.

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1Jeffrey A. Hirsch, “Sell In May and Go Where?”, stocktradersalmanac.com, April 25, 2011, http://blog.stocktradersalmanac.com/post/Sell-in-May-and-Go-where, (accessed May 9, 2013).