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Will Buy & Hold Beat Seasonal Investing In 2012?

  • Written by Syndicated Publisher No Comments Comments
    October 1, 2012

    For a while it looked like ‘Sell in May and Go Away’ was going to add to its long-term pattern of significantly out-performing buy & hold again this year.

    Not that over the long-term it has had to win every individual year to have achieved that performance. There are years when the corrections in the unfavorable season are minor, or when it’s more serious but the market recovers and is higher in the fall when a seasonal investor comes back into the market.

    However, seasonality so clearly wins over the long-term because the market quite often does experience serious corrections, and by far most of them take place in the unfavorable season, with the low often in the October/November time-frame. Obviously buy and hold as a strategy experiences losses of various degree every time in those years.

    However, in those years when seasonality fails, when the market makes additional gains while seasonal investors are out of the market, seasonal investors do not have losses as a result. They just miss out on those additional gains in the summer months that year.

    That makes for a considerable difference in the long-term performance of the two strategies, ‘Sell in May and Go Away’ out-performing ‘buy and hold’, and the market, over the long-term, and while taking roughly only 50% of market risk (and stress).  

    As Mark Hulbert, who tracks various market strategies in his well-known Hulbert Financial Digest, reported in an April article, over the last ten-year period (in the so-called ‘lost decade’),  the market averaged an annual return of 5.4%, while the basic ‘Sell in May and Go Away’ strategy averaged 7.0%, 30% more than buy and hold, while taking only 60% of market risk.

    The history goes back much further than that, the phrase ‘Buy in May and Go Away’ having been coined back in the 1970’s, as a result of studies by Ned Davis Research, Yale Hirsch, and Norman Fosbach.

    So seasonality’s performance in individual years is not of much importance to the success of the long–term strategy.

    But is it even a sure thing that ‘buy & hold’ will outperform seasonality in this individual year? 

    Many seem to think so, as Buy & Hold as a strategy is now being dumped on in the media, quite a reversal from a few months ago. But such is the short-term focus these days.

    The Dow topped out exactly on May 1 this year. And by June 4, the S&P 500 was down 9.1% and looking vulnerable to much more downside.

    That had many in the media singing the praises of Sell in May and Go Away.

    But as we now know, things were looking so ominous at that point that the Fed came out with promises of coming to the rescue if needed. And the market took off on the ‘great rally of hope’ from the June low, with a final double spike-up in reaction to the European Central Bank (ECB) action, and a week later the Fed’s QE3 announcement.

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    And with that the market was back above its level at the spring peak, and ‘Sell In May and Go Away’ is being derided as a strategy. “Obviously” it’s better to just buy and hold.

    But not quite so fast.

    The Dow is just 1.2% above its level on May 1, the S&P 500 just 2.4% above its May 1 level, and the Nasdaq just 2.2% higher.

    Is it not premature to be so sure that those who sold May 1 will not be happy and better off that they did so by the time they re-enter for the next favorable season?

    After all, we are coming into the month of October.

    What’s notable about October?

    On the positive side, October is the month that most often sees the re-entry signal for our Seasonal Timing Strategy (which is very different from the basic ‘Sell in May and Go Away’ strategy).

    But it also has a history of some brutal corrections. Both of the actual market crashes of the last 90 years, that of 1929 and of 1987, took place in October. And in Octobers there were also what The Stock Traders Almanac lists as, “the 554 point drop on October 27,1997, back-to-back massacres in 1978 and 1979, Friday the 13th in 1989, and the meltdown in 2008.”

    But with the S&P 500 only 2.4% above its May 1 level, it wouldn’t take a major meltdown to put ‘Sell in May and Go Away’ well ahead of buy & hold for the year.

    Other voices:

    Reuters: ‘HSBC PMI Slide Raises Risk of China’s Growth’. “China’s economy has almost certainly suffered a seventh straight quarter of slowing growth. . . . The HSBC China PMI Index showed overall factory activity shrank for an 11th consecutive month in September. . . . with a slide in export orders to a 42-month trough.”

    Barron’s Jim Strugger: “It pays to be cautious when the VIX is at muted levels and the market looks calm.’ “Seasoned, or perhaps I should say battle-scarred, investors are conditioned to view mid-teen VIX readings as a sign to be cautious about stocks. This instinct has preserved considerable amounts of money over the years, because muted volatility levels historically have been followed by sharp equity-market declines in which the VIX spiked toward 30, into the mid-40s and even above 80.”

    And so another Update on VIX.

    Every once in awhile we give you an update on the VIX Index (aka the Fear Index), as part of our analysis of investor sentiment.

    The VIX has been at the low level of fear (high level of bullishness and complacency) since mid-year. It started to rise some as the May-June correction began, but plunged back down to levels usually seen at market tops (vertical red lines) when that correction was aborted and the big June rally took over. Will it be different this time?

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    New Problems Coming For the Housing Recovery?

    Troubled homes have accounted for much of the increase in home sales that have raised hope that the housing industry has bottomed and is in recovery.

    Troubled homes include those in foreclosure and being sold or auctioned by banks, homes which the bank allows the owner to sell at a price significantly below the outstanding mortgage and forgives the remaining mortgage debt (short sales), and those on which the home-owner is underwater on their mortgage and the lender agrees to a reduction in mortgage principal so the owner can remain in the home and handle lower mortgage payments.

    But as Diana Olick points out on CNBC’s website, that debt forgiveness in short sales and mortgage principal reductions that has been super-charging home sales, may run into a brick wall very soon.

    As part of the 2008 $300 billion dollar ‘stimulus for at-risk-homeowners’, Congress passed the ‘Mortgage Forgiveness Debt Relief Act and Debt Cancellation’ bill. It said that the debt forgiveness from a short sale, or mortgage principal reduction agreement between lender and home-owner, would no longer be taxable as ‘income’ by the IRS.

    That act expires at the end of the year.

    If it is not extended, many home-owners resorting to short-sales may instead resort to bankruptcy, and many home-owners who could negotiate a mortgage principal reduction that makes them able to stay in the home and make the lower payments, may instead opt to abandon the house if they have to pay income taxes on that principal reduction.

    Why?

    Consider a family that bought or refinanced a $450,000 house near the bubble peak. After the bubble burst and the financial crisis plunged home prices, at least in many states like Florida, Nevada, Georgia, etc., they could easily find themselves owing $200,000 more than the home is now worth, and worse, having lost a job or taken a cut in pay, may not be able to make the mortgage payments even if willing to ignore that they are paying so much more for the house than it’s worth. A short-sale lets them out from under the hopeless burden, by allowing someone else to buy the house at its current value.

    But if the $200,000 debt forgiveness by the lender becomes taxable, meaning the home-owner would owe IRS $50,000 to $60,000 for the phantom ‘income’, money they don’t have, then what?

    Perhaps a major blow to the housing recovery that has been so dependent on the sales of troubled homes in finally seeing a decline in the inventory of unsold homes?

    Will Congress get it debated and extended in time when they come back from their election recess and have to get into the hard stuff like what to do about the looming fiscal cliff?

    More on the Market’s Seasonality.

    As noted above, as we enter October we also enter the month that most often sees our Seasonal Timing Strategy (STS) trigger its re-entry season for its annual favorable season.

    Our STS is quite different from ‘Sell in May and Go Away’, as it does not blindly enter and exit just because a calendar date arrives. In our research into seasonality for my 1999 book Riding the Bear – How to Prosper in the Coming Bear Market, we were looking for a reliable strategy that would allow investors to continue to profit from the 1990’s bull market, but keep the profits and add to them in bear markets.

    As it turned out seasonality showed by far the most promise. But obviously the market does not roll over into a correction, or launch into a new rally, on the same day every year. We also realized that the original research on seasonality was based on monthly data, the market’s level at the beginning of months (May 1, and Nov. 1).

    So first we applied daily data and came up with a different calendar date for entry and exit signals. Then, after considerably more research, and with the goal of making it a strictly mechanical strategy that would have no human input based on a so-called ‘feel for the market’, or personal bullishness or bearishness at the time, we added a simple technical indicator that would let the market tell us what it was doing as those calendar dates arrived.

    Was the technical indicator saying for instance in April that the market was still in a rally and the exit should be delayed. In the fall, as the potential re-entry calendar date arrived, was the indicator saying it was safe to re-enter, or that a correction was underway and the re-entry should be delayed?

    The result was a seasonal strategy, but one in which the exits into its unfavorable season can, and have, come any time between April and late June, and the re-entries between October and late November (with one re-entry not taking place until early December).

    Basic ‘Sell in May and Go Away’ seasonality had been confirmed long ago, and reconfirmed by academic studies in recent years that show the pattern is still not only consistent and robust in the U.S., but in 36 out of 37 global markets.

    Our very different STS strategy was devised and proven out by back-testing through the previous 50-years, And of course now it has been proven by 13 years of real-time use as a Street Smart Report portfolio.

    And the results have been dramatic. STS has significantly out-performed the basic ‘Sell In May’ strategy, and has doubled and tripled the performance of the market, therefore buy and hold, over the long-term. It has had only two years of actual losses, and they were small, 3.6% in 2008, and 4.2% in 2009. That compares to the market’s losses of as much as 36% in some of those 13 years.

    The next important juncture for our Seasonal Timing Strategy:

    Most of the re-entry signals, including the many years of back-testing, and the 13 years in real time, have taken place in October. And yes, they have not always been at a market low. Sometimes they have taken place when the market did not experience much of a summer correction, is already rallying, and STS is late in entering.

    However as noted, in some years, even though the calendar date arrives, the re-entry signal has not been triggered by the technical indicator until sometime in November or early December.

    So October should be an interesting month, especially a bit into it as the first acceptable calendar date approaches.  Click on link to see the performance and comparison table. Click here to learn more.

    To read my weekend newspaper column click hereAre Declining Oil Prices Predicting A Stock Market Decline- Sept. 28, 2012.

    Images: Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

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