The U.S. markets have gone through a sharp rotational correction over the past two months. Growth, small cap, and high beta stocks have all collapsed relative to defensive investments. The rotation raises the question: have we have seen the best the market has to offer this year or will the rotation to defensive utilities, staples, and late cycle basic material and energy names provide new leadership for another charge higher? We made the case in our ETF.com column in January 2014 that the middle of this year would be wrought with challenges given the mid-term election year trends and the new chairperson at the helm of the Federal Reserve. Are we at the point now?
We have all heard the saying: “Sell in May and go away.” That suggests investors would do well to be out of the market from May 1 through October 31. Is that just stock market lore or is there really something to it that investors need to pay attention to?
According to Ned Davis Research, since 1950 all of the market’s gains have come from October 31 through April 30. Let’s break out the two six-month seasonal time periods since 1950, November 1 – April 30 and May 1 – October 31, and look at the growth of $10,000 in each period. For example, $10,000 invested in the S&P 500 in 1950 has grown to $606,167 during the strongest six-month seasonal period while $10,000 invested in the weak six-month seasonal period has declined to $6,920.
Now, I actually think it is quite silly to base one’s investment decisions purely on what month we are in, but it is hard to argue the statistics. There is also the problem that once an accepted Wall Street adage such as “Sell in May and go away” becomes widely publicized in the press, it often does not prove true. Last year was a prime example, with many analysts proclaiming a need to get defensive because of the calendar. However, instead of declining during the “normal” seasonally weak period, the S&P 500 Index rose 11.1% from April through October.
If we break out the study a little further, it is revealed that all of the weakness experienced with this stock market lore has occurred in the mid-term election years. Since 1950, the mid-term election year is the only year to have had an average decline in the May 1 – October 31 period, with an average decline of 0.37%. The other three years in the cycle averaged gains of 1.82% during the May 1 – October 31 period. The chart below illustrates that the pattern of returns in the mid-term election years (blue) is dramatically different from other years (black). Which raises the question, should investors heed the warning about potential risks as we tread further in the second quarter? History suggests yes. In addition, the rotational correction that we have witnessed also hints at a market that is getting more defensive. For those investors who want to stay invested, despite the potential risks, we would heed the market’s recent shift to defensive allocations and look toward higher dividend plays.
Even in a declining market, there are opportunities somewhere – or at least areas that can offset losses occurring in the broader market. “Sell in May and go away” might have some truth in it; however, by digging a little deeper into market and economic history we can uncover more specific triggers for market declines over the summer months and make more educated investment decisions.
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