Coronavirus upends "sell in May" theory

If you follow this strategy, here's what to think about as April turns to May.

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If you factor in the "sell in May and go away" strategy to some extent, the timing and uncertainty surrounding COVID-19 might mean reconsidering how much significance you place on this and other seasonal trading patterns. Here's how you might think about "sell in May" in today's market.

What is "sell in May"?

This stock market adage was born from what the Stock Trader's Almanac calls the "best 6 months of the year." Historical data reveals that the top performing 6-month rolling period, on average, has been November through April. Hence, the saying investors should "sell in May and go away"—and come back in November.

Since 1945, the S&P 500 has gained a cumulative 6-month average of nearly 2% from May through October on a price return basis. That compares with a 6.7% average gain from November through April.1 Additionally, the S&P 500 has generated positive returns roughly two-thirds of the time from May through October, and 77% of the time from November through April.1 This outperformance is seen not just in large-cap stocks (as measured by the S&P 500), but also small-cap stocks (as measured by the S&P SmallCap 600) and global stocks (as measured by the S&P Global 1200).

Of course, it should be obvious that there are many caveats to this calendar-based trading pattern. For instance, returns have varied widely, not only between the November through April and May through October periods, but also within these time frames.

Moreover, "sell in May" doesn't account for the uniqueness of each period: the economic, business cycle, and market environment that differentiates now from the past. Quite obviously, the coronavirus pandemic—and resulting stock market volatility—may invalidate any merits of this strategy for the foreseeable future. Even with the huge rallies in recent days, US stocks (as measured by the S&P 500) are in the red for the November 2019 through April 2020 period. Moreover, given the significant uncertainty of both the attempts to contain the spread of the pandemic as well as the efficacy of the fiscal and monetary response to combat the economic impact of COVID-19, it is exceedingly difficult to predict if and when things might return to normal.

Consequently, it's better to think of this market adage not as hard rule, but rather a trend that might lead to some interesting insights. And in times like these—where the exogenous uncertainty of the COVID-19 pandemic has disrupted apparent patterns and fundamentally altered business as usual—you may want to reconsider incorporating seasonal market trends for the time being.

Rotate rather than retreat

If the pandemic does subside and the market returns to a more normal state, sector rotation may be a more appropriate takeaway from the sell in May calendar trend—according to analysis by CFRA in April 2019. Rather than exit the market, you could factor in seasonal patterns that have developed in recent years to your decision-making process.

From 19902 through April 2019, there was a clear divergence in performance among sectors between the 2 time frames—with cyclical sectors easily outpacing defensive sectors during the "best 6 months." Consumer discretionary, industrials, materials, and technology sectors notably outperformed the rest of the market from November through April.

Alternatively, defensive sectors outpaced the market from May through October during this period. For example, the health care and consumer staples sectors recorded an average increase of 4.9% and 4.4%, respectively. That compares with a 1.8% gain for the S&P 500.

CFRA looked at a hypothetical portfolio consisting of an equal weighting of consumer staples and health care sectors from May through October, and then rotated into an equal exposure of consumer discretionary, industrials, materials, and tech sectors from November through April. They found an increase in compound annual growth rates (CAGRs) and a reduction in annual volatility across large caps, small caps, and global stocks for this strategy versus respective benchmarks (see CFRA-Stovall Seasonal Rotation Custom Indices table). Note that these values do not include the impact of transaction costs, fees, or taxes.

As the table illustrates, the cap-weighted semiannual seasonal rotation strategy produced a 13.7% CAGR, compared with a 7.8% CAGR for the S&P 500. The standard deviation of returns was 15.6 for the seasonal rotation strategy, versus 16.6 for the S&P 500. Of course, as is the case with the "sell in May and go away" trading pattern, caveats to this strategy also exist. Returns have varied both across and within each period, and this seasonal investing approach may not be suitable in the context of a larger portfolio strategy.

Investing implications

It's important to remember that, even if conditions return to a more normal state, there is no way to know if the coronavirus pandemic will resurface—unless a vaccine or viable treatment methods are discovered. Looking to history shows that the so-called Spanish Flu's 2nd wave in 1918 was more deadly than the first.

Even if you were to consider a sector rotation strategy at some point in the future, there are many other factors to consider, including the risk of sector concentration implied by a defensive rotation strategy. As always, you should evaluate each investment opportunity on its own merit and with an eye toward how it may perform in the future, rather than solely focusing on how it has performed in the past. Any decision you make should be made within the context of your specific investing strategy.

For instance, if you do have positive gains and want to lock in some of those profits, you could consider a "sell in May and potentially stay" strategy. In other words, consider selling only those positions in May that you don’t want to be in for the long haul, and stick with your strategy for the rest of your portfolio. Of course, with stocks broadly in the red since the outset of the coronavirus pandemic, this may not be a relevant strategy right now.

It's also worth acknowledging that these types of strategies may only be suitable for active investors with shorter investment horizons, and even active investors need to consider their trading strategies within the context of a diversified portfolio that reflects their time horizon, risk tolerance, and financial situation.

In sum, should you "sell in May and go away"? Probably not, according to the historical data, as there may be better options if you are an active investor. If you are a long-term investor, there are more important factors that should influence your investment decisions—including your individual investing objectives, risk constraints, and tax circumstances. More importantly, COVID-19 has introduced unknown elements that might render seasonal patterns unreliable for the foreseeable future.

Next steps to consider

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