Will May’s Stock Market Performance Defy the Historial Trend?

Statistically the months from the end of October through the end of April, are in fact the best months of the year for investing while the six months from May through October are the “worst.”

It turns out there is a body of research that supports this theory and one of the best sources of information on this subject comes from my friend, Jeffrey Hirsch, at “Stock Trader’s Almanac”where he has developed a trading indicator based on this seasonality and the historical returns it has generated.

Let’s take a look at some of “Stock Traders Almanac’s” findings:

On a historical basis, the research indicates that the market generates better rates of return from November through April than from May through October.  And the difference is significant.

Over a 60 year period, if you had invested on May 1st and closed your position at the end of October, you would have lost money.  On the other hand, if you had invested only in the “six good months” you would have made money over the same time.

Now of course, there were years when this seasonal indicator didn’t work, but it does appear to offer a significant edge in risk management and investment returns.  In fact, during the last bear market, investing only in the six good months of the year actually resulted in a net gain versus a sizeable loss over the course of 2000-2002.

And here’s another significant factor.  I often point out how the S&P 500 (NYSEARCA:SPY) and the Dow Jones Industrial Average (NYSEARCA:DIA) have generated a negative rate of return between 2000 and 2012.  Both of the main averages are still below their 2000 highs and so investors have lost nearly 10 years of their investing lives.  But someone who invested in only the six “good months” since 2000 would be sitting on profits instead of long term losses.

Also, it turns out that if you invested in just the six good months of the year, you would have beaten the overall return of the major indexes while having been invested for only half the time, thereby reducing your market risk and freeing up your assets to earn interest in low risk money market or Treasury investments.

This phenomenon is often referred to as “sell in May and go away.”  For investors watching the ongoing volatility in Europe and recession spreading around the continent, it could be a good idea to keep in mind that May starts this Tuesday.

If you see value in this indicator and its history, you have several options to consider:

  1. You could move to the safety of cash.
  2. You could buy put options to hedge positions you don’t want to sell.
  3. You could use inverse ETFs that go up in value as markets decline.  These can be tricky as they are readjusted daily and can generate tracking errors.
  4. You could move more assets to bonds and bond ETFs which would likely rise if stocks should fall.

Bottom Line: So time will tell if “sell in May and go away” proves to be accurate in 2012 or not, however, history is certainly on this seasonal indicator’s side.

John Nyaradi is the author of The ETF Investing Premium Newsletter.