Tuesday, May 30, 2006

Sell in May and Go Away

The advice to “sell in May and go away” has been with us for some time. It harkens back to decades gone by when the concentration of summer vacation plans in July and August led to calendar effects in the London stock market. I have been hearing and seeing this phrase more and more recently, leading me to ask whether it really works on either “side of the pond.”

Technicians tell us that indeed it does! David Chapman of Union Securities Ltd. and director of the Millennium Bullion Fund in Canada, says summer is consistently a low season with the stock market bottoming out in September and then rallying by November. Chapman gets support from academia. In 2001, Ben Jacobsen of Massey University and Sven Bouman of AEGON Group completed a study on the “sell in May” adage, which they call the “Halloween Effect.” The study documented the seasonal effect in 36 of 37 developed and emerging markets with the effect most pronounced in European countries. The sample evidence suggested the United Kingdom effect has been noticeable since 1694.

Stock Trader’s Almanac tracked the investment results of the Halloween Effect. If an investor had put $10,000 into the Dow Industrials on November 1st and then sold it on April 30th in each year beginning in 1950, he would have earned $492,060 on the $10,000 investment by the end of 2004. That is impressive! If the reverse strategy had been followed - $10,000 invested in the Dow on May 1st and sold on October 31st - the same 54-year investment period would have resulted in a $318 loss.

We favor the “Sell in May” title over the “Halloween Effect,” as it better encompasses the true nature of this calendar effect. People are habitual in nature, following the same behaviors year-in and year-out that either take money out or put money into the stock market. They go on vacation in the same month…every year. Bonuses are handed out and invested in the same January to March time frame…every year. The peak holiday season from November to January drives earnings in the fourth and first calendar quarter…every year.

Market clichés should be viewed with some skepticism to my way of thinking, especially if they negate the contribution of fundamental analysts like me! Clearly, selling in May would work quite well and require absolutely no additional fundamental analysis if you were prepared to follow a “timing” strategy and restricted your investment to the Dow Industrials. No one has provided us with data on the merits of the “sell in May” strategy using a small cap portfolio. Despite my bias for fundamentally driven investment strategies, I think it would be a worthwhile study, providing valuable insight for both technical and fundamental approaches to the market.

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