Even though actual earnings growth has outpaced estimates for the last twelve quarters as of the end of the fourth quarter (Q4) 2014, consensus estimates are projecting earnings to decline by 4.6% in Q1 2015. Might a weaker earnings season and a seasonal market pattern mean it could be time to “sell in May and go away?”
Unlike some other perceived calendar anomalies—such as the January effect—this pattern has been relatively reliable in recent years with regard to investors “going away.” Indeed, trading volumes have been very low the last five summers. But while returns for the Dow Jones Industrial Average, on average, have been lower in the summer months than in the winter and spring over the last 50 years1, they have varied widely from year to year. In fact, during the last two Mays, the market rose.
So, if you have a long-term outlook, selling in May might not be the smartest strategy. It really depends on the year, your goals, and your investment strategy.
Lower volume, lower returns
The tendency for many investors to “go away” until the fall has been strong since the financial crisis, evidenced by the significant decline in summer trading volumes since 2010. For instance, the daily average volume on the New York Stock Exchange was less than 3 billion last summer, one-fourth of the 12.3 billion peak during the financial crisis.
More important for traders, of course, is the potential impact on returns. Over the past 50 years, the Dow has produced, on average, a 7.5% return during the winter months while being essentially flat during the summer months.1
It’s important to realize that averages don’t tell the full story, however. From 1928 to 2014, stocks produced positive returns 49 times during the month of May, and negative returns 38 times (see the table below). That’s 56% of the time up, and 44% down. Plus, the variation in returns was dramatic. While the average May return over the period was 0.6%, the largest drop was 23% in 1932, and the biggest bounce was 23% in 1933. More recently, the market rose 3% during May 2013, and 2% in 2014.
Stocks have recorded positive gains more often than not during May.
|Year||May Return||Year||May Return||Year||May Return|
|Source: Fidelity Investments, as of April 20, 2015.
Constructing a portfolio and forecasting returns based solely on the theory of selling in May and buying when the summer is over can be a risky proposition. Moreover, even if you are a proponent of this theory, May might not be the optimal time to close your positions for the summer. Says Ching Tan, technical analyst with Fidelity: “If you‘re out of the market during May, history shows that you could miss out on opportunities to generate positive returns.”
If you do have positive gains and want to lock in those profits, Tan suggests 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.
If volume does indeed wind down in the coming months, and the market trends strongly in either direction, you may want to weigh whether any market moves have staying power. From a technical perspective, rallies on low volume are said to “lack conviction.” That is, a rally that takes place on low volume may not be sustainable, and, similarly, a decline on low volume might not either.
While it’s not advisable to trade based solely on a single pattern, it may be possible to improve your market forecast and better position your portfolio by factoring in the potential volume implications of “Sell in May.”
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917