Should you "sell in May"?

Around this time each year, some investors ask the question: Should I "sell in May and go away?" Last year, it may not have been a bad idea, as the S&P 500 lost 20% for the full year. Only energy stocks among the 11 US stock market sectors finished with gains.

This year, stocks have gotten off to a better start, and so there may be better reason to take this strategy with a grain of salt. So, should you sell in May?

What is the "Sell in May and go away" theory?

"Sell in May and go away" is a stock market adage based on 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.

But this trading theory has flaws. More often than not, stocks tend to record gains throughout the year, on average, and thus selling in May generally doesn't make a lot of sense. History suggests the opportunity cost of periodically exiting and reentering the market may be significant. Also, the ease of monitoring your investments (compared with decades ago when this calendar theory was created) means it's possible to more easily monitor the market and make changes to your investments as needed at any time during the year.

With that said, there may be some interesting takeaways from this calendar trend. Here's how you might think about "sell in May" in today's market.

Rotate rather than retreat

Since 1990, the S&P 500 has gained an average of about 2% from May through October. That compares with a roughly 7% average gain from November through April. This outperformance is seen not just in large-cap stocks, but also small-cap stocks and global stocks (as measured by respective S&P indexes). What's more, rotational strategies—which we will dive into shortly—across market caps have historically shown even better average performance (see How Seasonal Rotation Strategies Compare chart).

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.

With that said, if you are making tactical trades with some percentage of your portfolio, and calendar trends are a component of your strategy, sector rotation may be a more appropriate takeaway from the sell in May calendar trend—according to analysis by the Center for Financial Research and Analysis (CFRA). Rather than exit the market, you could factor in seasonal patterns that have developed in recent years to augment your decision-making process.

According to CFRA, since 1990 there has been a clear divergence in performance among sectors between the 2 time frames—with cyclical sectors easily outpacing defensive sectors, on average, 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. Using these observations, CFRA created an equal-weighted seasonal rotation index in April 2018.

The bottom line on "sell in May"

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, have that cash on hand to adjust your investment mix as needed, and stick with your strategy for the rest of your portfolio.

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.