2017 has gotten off to a strong start for stocks. The S&P 500 has gained 6% on a total-return basis year-to-date. Corporate earnings are expected to increase for the third straight quarter—S&P Capital IQ consensus earnings forecasts a more than 9% year-over-year increase in S&P 500 operating results, potentially reaching a record 12-month high of $120.30 per share. And volatility—as measured by the CBOE Volatility Index (VIX)—remains historically low (see VIX chart, below).
But risks remain:
- Valuations, broadly speaking, may be rich. The S&P 500 Index has a price/earnings ratio of about 18.2x (as of April 6, 2017), based on expected earnings in 2017, which is more than 10% above its 15-year average of 16.5x.
- Volatility could resurface. Possible triggers might include slower-than-expected growth in emerging markets (specifically, China); delays or unexpected developments in government trade, tax, and fiscal policies; and of course, rising geopolitical risks in many markets around the world.
- Policy uncertainty lingers. Health care, tax, and infrastructure spending proposals from the new administration may have helped fuel the rally in stocks post-election, however, much uncertainty remains if these policies will make it through the legislative process.
With all this in mind as the calendar keeps turning, should you “sell in May and go away,” as the oft-cited market adage suggests? Not necessarily, according to historical data.
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. The same can be said for active investors, for whom there may be more appealing strategies—with sector rotation among those to consider.
May is not so bad
When it comes to performance by month of the year, May ranks among the bottom half for stocks (historically, September has the distinction of being the worst month of the year). However, May has produced positive returns more often than not.
From 1928 through 2016, the S&P 500 Index has generated positive returns 50 times in May, negative returns 39 times, and the variation in returns has been dramatic (see the table below).
Stocks have recorded positive gains more often than not during May.
|Mean return (%)||0.0%|
|Median return (%)||0.6|
|Maximum return (%)||23.1|
|Minimum return (%)||−23.9|
|Standard deviation (%)||6.0|
|Source: FactSet, as of March 30, 2017. Stock price returns are represented by the S&P 500.|
For the active investor with a short-term outlook, May’s average return of 0% does not suggest that mechanically selling in May is optimal. Of course, averages don’t tell the whole story, as returns have varied widely; the largest drop was 23% in 1932, and the biggest bounce was 23% in 1933. However, on the whole, May is a relatively positive to mixed bag in terms of returns, and so selling does not seem prudent from a historical perspective.
A sector strategy instead of selling
Looking beyond May, investors with a relatively longer investment horizon may find it interesting to know that stocks have historically tended to underperform over the ensuing five months after May, compared with the prior, so-called best six months.
Since 1928, the S&P 500 Index has gained, on average, roughly 5% from November through April, while adding just 2.0% from May through October. However, annual returns have varied widely within these two periods. Moreover, history shows that for investors who are actively trading over short time frames, there may be better strategies than simply selling in May and buying back in November.
Sam Stovall, equity analyst with S&P Capital IQ, says their analysis of five different strategies finds the best has historically been a sector rotation strategy (see chart and table below). “Analyzing five strategies over the past 25 years that incorporated staying invested, cash, bonds, smart beta (e.g., low volatility), and S&P 500 sectors, the strategy of rotating into two defensive sectors—consumer staples and health care—has offered the highest returns with below-market volatility.”
The five strategies to consider are:
- Stay invested—Holding the S&P 500 Index from May to November.
- Cash—Going to cash on May 1 and earning the three-month T-bill return until October 31.
- Bonds—Earning the Barclays Aggregate Bond Index return beginning May 1 and ending on October 31.
- Low-volatility stocks—Earning the S&P 500 Low Volatility Index return beginning May 1 and ending on October 31.
- Sectors—Purchasing a portfolio of 50% consumer staples and 50% health care on May 1 and selling on October 31.
Since December 1990, the strategy of going to cash offered lower standard deviation (e.g., lower volatility) and a lower maximum drawdown (e.g., worst annual return), compared with staying invested in the S&P, but it has produced the lowest compound annual growth rate (CAGRs) of all the five strategies compared. Thus, longer-term investors should not hurry to sell their positions in May.
For the active investor, rotating into bonds or a low-volatility index from May to November has produced higher CAGRs and frequencies of outperformance (with higher volatility) compared with going to cash. It is the portfolio of 50% consumer staples and 50% health care that produces the highest CAGR of the five, and it actually had lower volatility (14) compared with the low-volatility strategy (15), as well as staying invested in the broad stock market (18).
Given that past performance is no guarantee of future results, this does not mean active investors should sell their positions come May and rotate into these two sectors. Even if you were to consider a sector rotation strategy, there are many other factors to consider, one of which is analyzing the sectors of the market that may be best positioned for current market conditions. 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.
All these strategies are among the many choices you have, and 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. Additionally, if you are reassessing your portfolio, it may be beneficial to consider positioning your portfolio for potential changes in the phase of the business cycle, evolving economic conditions, and market-moving news, rather than a singular calendar anomaly.
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.
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