Wednesday, April 10, 2013

May To October Is Less Bad Than You Think

One of the axioms of Wall Street is 'sell in May and buy after Halloween'.  Mark Hulbert says that over the past 50 years, the Dow has an average return of 7.5% from November through April ("winter") versus an average loss of 0.1% from May through October ("summer").

So, is the summer period that awful?

Using SPX instead of the Dow and including dividends, since 1970, the data still favors winter over summer: the average return is 9% in winter versus 2% in summer.

But this data is skewed by some outliers; using median values, winter's return is 8% versus 4% in summer. In other words, while the returns are usually two times higher during winter, the returns in summer are typically positive. You might sell in May and buy back higher in November.

Digging in further confirms this conclusion. Overall, 21% of winters since 1970 have been negative; summers are a bit higher at 28%. Really bad seasons with losses of more than 10% don't favor one season over the other: 7% of winters versus 12% of summers. Summer is worse, but the difference isn't much.

There are two factors at play influencing typical seasonal returns and investor perceptions.

The first one is this: about 65% of the worst months since 1970 occurred during the summer. This is true whether you look at the top 20 worst months or all months with a 5% or greater loss. When a bad month happens, it is twice as likely during the summer as the winter. 

But the other factor, equally important, is that great returns overwhelming take place in winter. Almost half (48%) of winters produce a return of 10% or more, just like the one occurring now. In comparison, only 17% of summers have produced a great return. When a good stretch in the market happens, it is almost three times as likely during the winter as the summer.

The summer months start in a few weeks. The probability of a truly bad month is higher and the probability of a really great stretch of months is much lower. But the expected return over the next 6 months is, on its own, positive. As we have seen in the past few years, a dip in summer is often a great entry point.

First chart: Since 1980, some of the notable declines have been during the summer (yellow). Note that some years have no notable decline and in those that do, the declines are generally confined to 1-3 months, not the entire 6 month season.

Second chart: Below are the SPX returns by season since 1970. Overall, the percentage of negative summers (red) and winters (blue) is not that different. There are two big differences between the seasons. First, the large returns tend to happen in the winter, not summer. Second, the big falls tend to happen in the summer not the winter.

Third chart: Below is the monthly performance of the Dow from Bespoke. June and September have been particularly weak but note that July has consistently been strong. Summer is not as homogenous as you might think.