Next week we start the month of May, which has historically been one of the worst performing months for stock markets worldwide. The Stock Trader’s Almanac did a study on the performance of the Dow Jones Industrial Average since 1950 and found it has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. This study has built the theory of Halloween trade and the adage ‘sell in May and go away.’

The strategy

The “Sell in May and go away” trading strategy is elegant in its simplicity. The theory suggests traders should sell their portfolio in May and enter the market again in November to avoid the underperforming months in between. The theory was further tested across 108 stock markets and over 319 years (for some), and was found to generate 4.5% p.a more than holding a position May to October. So this begs the obvious question… Does it work?

Stats Don’t Lie

Macquarie Research recently investigated this phenomenon as it existed in the European Markets. From the late 1980’s to now the researchers concluded that most gains in the Stoxx 600 and the FTSE350 were recorded during the months from November to April. This, together with Stock Trader’s Almanac’s research in the US provides some grounds for the strategy. But does it hold true in Australia?

Examining returns over the last 20 years would suggest that April and May are clearly the worst performing months. It also shows that the period from November to April outperforms the period from May to October. So while we can see some long-term trends, it is also important to look at the data closely.

By looking at the returns over the period from 2000 to 2010 show we see the results in Australia are patchy. Clearly investors would have missed out big time if they used the strategy in 2009, missing out on returns of around 24.20%. And other years such as 2003 make it clear that the strategy is not a silver bullet.

Considerations

Before you lurch in to selling your portfolio, you must consider that any study is bound by a bunch of assumptions. This includes sample size, start dates and the like.

We also must consider seasonality in markets. Companies report around April/May for 1st Quarter results and northern hemisphere holidays can mean the usual analysts/traders will go on “summer” holidays and therefore wind down positions, or not take a view over the period.

What can we take away from this?

While in general markets experience some volatility and lower returns during the period from May to October, results are varied. Before traders ‘sell in May and go away’ they should look at the trends driving the market.

There is no replacement for a sound and well researched strategy to investing.