Sell in May?

Numerous studies show that since World War II, as much as 99% of stock market returns have been generated between November 1 and May 1. Good friend and fishing buddy David Kotok of Cumberland Advisors sums it up nicely:

"According to the Ned Davis (NDR) database, starting in 1950, $10,000 invested in the S&P 500 Index every May 1st and then liquidated every October 31st would only be worth $10,026 today. That's right: had you stayed out of the stock market from November through April and only been in the market from May through October, you would have had no change during the last 57 years. 21 of those years would have been negative; 36 were positive. Thi s happened during the same period that stock prices were rising about 75% of the time and markets made extended upward moves.

"Consider the results of the reverse strategy. Buy the S&P 500 Index on November 1st and sell all your stocks on May 1st. The outcome is dramatically different. Your original $10,000 would now be worth $372,890 as of April 30th closing prices in 2008. Out of the 58 periods you would have had positive results in 45 of them and negative results in only 13 years."

*** 4/30/12

I'm perfectly willing to believe that there is a seasonal component to stocks' price appreciation that is inconsistent with efficient markets, but these data aren't enough to judge the efficacy of a seasonal switching strategy. In that regard, NDR's methodology suffers from several shortcomings: For one, it assumes that when the money isn't invested in stocks, it earns no return whatsoever instead of being invested in Treasury bills. Furthermore, their data do not account for dividends, a critical component of stock returns. Finally, there is no benchmark data corresponding to a straightforward "buy and hold" strategy.

In order to address these issues, I performed my own calculations, using data series from Ibbotson Associates (a unit of Morningstar) that begin in 1926.

There are two key observations here:

The "sell in May" strategy soundly beat the converse strategy, with a margin of outperformance that exceeds 3 percentage points on an annualized basis.

However, "Sell in May" underperformed buy-and-hold; in fact, the outperformance of buy-and-hold is understated because the returns in the table assume no transaction costs and no tax impact.