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Sell In May: Particularly In Mid-Term Election Years!

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    April 15, 2014

    Last week I discussed that the month of April wraps up the “seasonally strong”investment period of the year and leads two of the weakest months of the year.

    As the markets roll into the early summer months May and June tend to be some of weakest months of the year along with September.  This is where the old adage of “Sell In May” is derived from.  Of course, while not every summer period has been a dud, history shows that being invested during summer months is a “hit or miss” bet at best.

    However, before you slip into a warm bath of investment bliss, it is important to remember that just because the data suggests that April will “probably” be a positive return month for the market, there is also the “possibility” it will not.  With a ratio of 43 losing months to 72 positive one, there is a 37% chance that April will yield a negative return.

    In this past weekend’s newsletter, we took this analysis to the next step looking at the statistics behind the old adage “Sell In May And Go Away.”

    As the markets roll into the early summer months May and June tend to be some of weakest months of the year along with September. This is where the old adage of “Sell In May” is derived from. Of course, while not every summer period has been a dud, history does show that being invested during summer months is a “hit or miss” bet at best as shown in the table to the left (click to expand).

    However, there are many academic studies going back to the 1970’s which have confirmed the pattern as well.  As Sy Harding, via Financial Sense, recently noted an an academic study published in the American Economic Review in 2002 concluded that,

    “Surprisingly, we found this inherited wisdom of Sell in May to be true in 36 of 37 developed and emerging markets. Evidence shows that, in the United Kingdom, the seasonal effect has been noticeable since the year 1694. The additional risk-adjusted outperformance [over buy and hold] ranges between 1.5% and 8.9% annually, depending on the country being considered. The effect is robust over time, economically significant, unlikely to be caused by data-mining, and not related to taking excessive risk.”

    Furthermore, a 2012 study of the 40-year period from 1970-2011, published by the Social Science Research Network, also noted that,

    “Surprising to us, the old adage “Sell in May and Go Away” remains good advice. On average, returns are 10 percentage points higher in November to April semesters than in May to October semesters.”

    In spite of decades of such studies and overwhelming evidence, the financial media still refers to market seasonality not as fact, but as a “theory.” They point out that it’s an “iffy thing”, since some years it doesn’t work out, and investors can be “hurt” by being out of the market in the summer months. Of course, it really isn’t the investors that are hurt by being out of the market, but the income statments of Wall Street.

    While there are some years that have posted sizable gains during the summer months, such years do not invalidate the long term statistical probabilities. As the table shows above, the average annual return from the summer months is significantly poorer than the fall and winter. To show the impact of that performance differential, I constructed the following chart which shows the growth of $10,000 invested in each of the seasonal periods.

    Adding The Midterm Election Cycle

    While it seems absolutely clear that one should just cash in their portfolio in April, and come back in November, there are plenty of years where the markets rose during the summer months. With the Federal Reserve still inducing monetary liquidity into the financial markets could this coming summer be one of those positive years?  Possibly.  However, this year in particular adds an additional dynamic to the conversation as it is a mid-term election year which has historically had implications for the stock market in the short term.  According to Jeffrey Hirsch of Stock Trader’s Almanac:

    “Midterm election years are historically prone to bottoms, especially in October and 2014 is also a ‘fourth’ year, which has the fourth best record in the decennial cycle for 132 years. Of the last four midterm election years since the start of the Great Depression (1934, 1954, 1974, 1994) that were also fourth years, only 1954 was impressive.”

    discussed this specific issue previously:

    The powerful rally in 2013, which had no real pause, makes 2014 more vulnerable to a more significant correction. Since 1833, the average peak-to-trough fall in US stocks during a midterm year was -12.76%.  The minimum decline of 0.6% occurred in 1894 while the maximum pullback was -33.8% in 1930.  However, the good news is that these corrections tend to occur in the 2nd and 3rd quarters of the year with an advance heading into year end.   The win ratio for all mid-term election years has been 60% with an average overall return of 4.16%.

    Midterm election years are also notoriously weaker when Democrats are in control, but in the last 13 quadrennial cycles since 1961, 9 of the 16 bear markets bottomed in the midterm year.

    However, when the midterm year followed a strongly positive post-election year, as in 2013, the annual return fell to just 2.4% on average.  The chart below, from Stock Trader’s Almanac, shows the mid-year correction that generally accompanies a mid-term election year.

    With the markets falling by an average of 12% since 1833, and 6% since WWII, the summer months of mid-term election years have not been kind to investors.

    However, let’s sum up the risks at play in the markets currently:

    • The Federal Reserve is extracting liquidity from the markets.
    • Interest rates are potentially rising
    • 2013 was an exceptionally strong year for the markets.
    • Markets have gone an exceptionally long period of time without a 10% correction.
    • The “momentum” play has cracked (biotechs, low float stocks)
    • Mid-term election years, particularly when Democrats are in control, have been weak during the summer months.

    While there is certainly a possibility that this summer could yield a positive return, there are enough concerns to be more cautious than normal. While there is no guarantee that this summer will produce a negative return overall, it certainly doesn’t negate a pretty nasty hiccup along the way.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.


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