Dow Jones Industrial Average, S&P 500: Sell In May and Re-Enter When?

Wall streetSy Harding: It’s that time of year when I remind you of the stock market’s remarkable history of making most of its gains in the winter months, while if there is a problem it usually hits in the summer or fall months. Most investors know it as ‘Sell in May and Go Away’.

Academic studies going back many decades confirm that an investor who simply bought the Dow Jones Industrial Average (INDEXDJX:.DJI) or S&P 500 (INDEXSP:.INX) via an index fund on November 1 each year, and moved to cash on May 1, would out-perform the market over the long-term by a significant amount, and while taking only 50% of market risk.

That is even though in some years the market continues to make gains in its unfavorable season, which of course a seasonal investor misses out on.

It outperforms because when a market correction does take place in the unfavorable summer and fall months, it’s often a significant decline.

A buy and hold investor is guaranteed to run into every one of those, and will often need much of the next rally just to get back to even. Meanwhile, a seasonal investor avoids most of those corrections, gets back in for the typical winter months rally, and builds up additional profits right away.

The most common misunderstanding regarding ‘Sell in May’ is that many assume it means the market should roll over into a correction in May or June. When it doesn’t they assume it won’t work that year. However, all the pattern says is that there is likely to be a correction sometime between May and the re-entry in the fall.

Sometimes the market does roll over into a correction in May or June. Just as often, the corrections take place in the fall, with the low often in October.

For instance, the 1987 crash took place in October (as did the only other market crash of the last 100 years, that of 1929).

Three years after the 1987 crash, the 1990 bear market ended in October.

In 1997, a late summer correction ended in late October, with the Dow down 13% from its peak. A year later, the 1998 ‘mini-crash’ began in July and bottomed in October, with the Dow down 18.2%.

Even in the very positive market of 1999, a correction began in August that had the Dow down 12% at the low in October.

In 2001, the first year of the severe 2000-2002 bear market, the Dow reached a low a bit earlier, on September 21, but then launched into a significant 29% rally to the following spring. A seasonal investor would have missed the big decline that was the first leg down of that bear market, and then been back in for most of the big rally off the late September low.

In 2002, a seasonal investor would have missed most of the second leg down of the bear market. And it also bottomed in October.

In the financial meltdown in 2008, the worst of it again took place in the summer and fall, the Dow losing 30% of its value between May 1 and November 1.

In 2011, the European debt crisis, a slowing of the U.S. economic recovery, and the threat of a government shutdown, had the market topped out in May, and the bottom took place in – you guessed it – October, with the Dow down 17% from its May 1 level.

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