Kvetch in May: Why Market Timing Isn't Everything

Photograph by Lars Thulin

All hail Memorial Day weekend. In the tradition of my Miami childhood, ‘tis the season to don Crockett & Tubbs white pants and flaunt the right to bare arms. Hedgies and traders clad in Sperry Docksiders bolt Gotham for the leafy, saltwater-sprayed indolence of the Hamptons. The market’s volume dips to a trickle.

And so “Sell in May and Go Away” becomes the mantra of choice. Indeed, this strategy has been especially useful over the past two years, with markets rallying to start the year and plunging between the onset of summer and autumn. One minute, the world’s not so bad, come to think of it, and stocks are hitting new highs. Then, with complacency all the rage, another PIIGS-led panic ripples across the pond. Maybe Europe’s denial about the urgency of its financial crisis is directly proportional to the temperature outside. Plus every man, woman, and baguette on the continent gets 30 weeks a year of paid vacation, I’m told, complete with a government-issued spa stay. But I digress.

Point is: Can you time the market?

The folks at Leuthold Group did a surprising analysis of the merits of going defensive in May—a strategy they call “Sell in May … without actually selling.” (After all, portfolio managers cannot just liquidate their portfolios and sit on cash for several months.) But they could sell volatility to go long the fuddy-duddy.

Leuthold calculated that if you had owned cyclical sectors (say tech and financials) from November through April and then switched into defensive sectors (utilities and health care, for example) from May through October, you’d have posted an annual return of 15.5 percent since 1989, compared with the S&P 500’s 8.6 percent annual gain. While 23 years of data does not prove an immutable market fact, this is a huge differential, making an original $10,000 investment compound into $275,000, vs. $67,000.

But anyone who’s taken college-level finance is supposed to know that timing the market is a fool’s game. “A look at the actual data shows that the intense focus on this seasonal trend might be yet another case of investors placing too much weight on the most recent events,” writes Daniel Putnam of InvestorPlace, who analyzed the past 40 years of performance for the S&P 500 Index during the May 1-Sept. 30 interval. He found that stocks are as likely to rise through most or all of the period as they are to fall. True, the S&P 500 hit its high in May on nine occasions. But  it peaked in September on 13 occasions, in June three times, July eight times, and seven times in August.

“The lesson,” Putnam writes, “is that more often than not, an investor who took the saying literally and sold on May 1 almost invariably gave up some upside.”

So why the endurance of the “Sell in May” meme? Maybe it’s summer’s recent knack for hosting market disasters, from 2001 and 2002′s tech wrecks to 2008′s mortgage meltdown and last year’s renewed kvetching over Europe and the U.S. credit rating. The mid-section of 1974, a brutish time for the American psyche, saw a 30 percent plunge. But back out these calamitous episodes and the S&P 500′s average May-September price return has been 3.55 percent over the past four decades. Putnam says investors should resist the urge to indulge their recency bias.

For my part, I have no recency bias. So if you’ll excuse me, there’s this party out in the burbs that I must get to.

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