After plummeting 10.5% from the start of 2016 to February 11, the S&P 500® Index recouped all its losses by early April, thanks in part to signs of steady U.S. growth, stabilizing oil prices, and a potentially slower pace of interest rate hikes by the Federal Reserve.
But risks remain:
- Earnings are under pressure. S&P Global Market Intelligence estimates that S&P 500® Index earnings for the first quarter of 2016 will be $26.25 per share, a 7.9% year-over-year decrease and the third successive quarterly decline (due in large part to declining earnings in the energy sector).
- Valuations, broadly speaking, may be rich. The S&P 500® Index is trading at 17.3x its forward 12-month price-to-earnings ratio, which is almost 5% above its 15-year average of 16.5x.1
- Volatility could reignite. Possible triggers include persistent signs of an ongoing slowdown in emerging markets (specifically, China) and the potential for Britain to exit the eurozone after a vote on June 23, commonly referred to as the “Brexit.”
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, as we’ll demonstrate using 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, and there may be more appealing strategies—with sector rotation among those to consider.
May is not so bad
May has produced positive returns more often than not. From 1928 to 2015, the S&P 500® Index has generated positive returns 49 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.
|Source: FactSet, as of April 22, 2016. Stock returns are represented by the S&P 500.
For the active investor with a short-term outlook, May’s average return of -0.1% does not suggest that mechanically selling in May is optimal. Of course, averages don’t tell the whole story, as returns varied widely; the largest drop was 23% in 1932, and the biggest bounce was 23% in 1933.1 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 six months after May, compared with the prior, so-called best six months. Since 1928, the S&P 500® Index has gained, on average, roughly 5.1% from November through April, while adding just 1.9% from May through October.2 However, annual returns have varied widely during these two periods. Moreover, history shows that for both the short- and long-term investor, 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 of all the five strategies compared. Thus, longer-term investors need not necessarily 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 (14.4) compared with the low-volatility strategy (15.0), as well as staying invested in the broad stock market (18.1).
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.
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. 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.
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