Up there with ‘look before you leap’ and ‘don’t judge a book by its cover’ ranks ‘sell in May and go away’ for nauseating adages that everybody preaches and nobody practices.
It is the stock market equivalent of a rain dance... forgivable if you don’t know any better, quaint if you’re doing it ‘for old-time’s sake,' but a daft idea to put your money behind.
The principle was cooked up after the Stock Market Almanac’s study into market timing. It aimed to find out when the best stock market performance has been achieved over a 56-year testing period. Their research showed that returns from October to April were great, while returns from May to September were poor. Hence the rhyme, ‘Sell in May and go away don’t come back until St. Ledger’s Day,’ which is a horse race in September.
More recently, research by Plexus Asset Management shows returns of October to April from January 1950 to December 2007 were 8.5% per annum whereas those of the May to September were 3.2% a year.
So evidence shows that ‘Sell in May’ works more years than it doesn’t... so why look this gift-horse in the mouth?
Well, digging a little deeper we can see that the best strategy would not have been to ‘Sell in May’ but to ride out the whole year and produce an average return of 11.9% a year. And that’s before you factor in transaction fees and tax that you’d incur by following the rhyme’s advice.
Why does the market do worse in the summer?
John Bearman suggests it’s something to do with trading volumes. "The theory is that markets are more likely to lose ground over the summer months when traders and brokers loosen their ties and take time out to sip Pimms on the riverbank at Henley, eat strawberries at Wimbledon and gently roast themselves on Mediterranean beaches," said Bearman.
A nice idea, but it conflicts with the hyper-competitive reality of the financial markets where any true market anomaly would be arbitraged away very quickly.
Attempts to overlay evergreen rationales are dismissible as the economic backdrop changes from year to year.
This kind of ‘narrative fallacy’ — where one creates a story post-hoc so that an event will seem to have a cause — should have no place in your investment strategy.
Imagine if stocks beginning with the letter P outperformed the market. Would you take that as a potential money spinner? It’s just a statistical coincidence. With 26 letters, one of them was going to capitalise the most profitable companies, just by chance. And similarly, with so many combinations of months, there was going to be one period which tends to produce the worst performance.
If the market is going to fall this summer, which it probably will:
Blame the deteriorating property market;
Blame the deleveraging investment banks;
Blame the volatile debt markets;
Blame the stingy UK consumer;
Or blame HM Revenue & Customs' ill-conceived proposals.
But leave St Ledger out of it. This kind of indoctrinated narrative fallacy is fun to comment on but dangerous to invest with.
Other fun flukes
The stock market rarely rewards the obvious, and the summer sell-off is not the only flimsy observation that we should take with a pinch of salt. Here are some classics:
Magazine Cover indicator
Generally said to be ‘behind the curve,’ magazine covers will feature stories that resonate with the public at that moment. The highest profile story, the cover story is usually said to be priced into the market.
Because of this, it is said to be a great contrarian indicator, i.e. When Business Week runs a headline, "The Death of Equities", as they did in 1982, a major bull run is well on the way.
A nice idea but there is little other than anecdotal evidence to back it up.
Santa Claus rally
A Santa Claus rally happens when the stock market picks up in December, in the final trading week of the year.
Otherwise known as the ‘December Effect’ it is said to be representative of clever traders buying into the market before an injection of additional funds into the market in January.
As with ‘Sell in May,’ if it ever was a real phenomenon, it’s not anymore. The clever quantum physicists and their clever trading algorithms would target such market-timing phenomena and arbitrage it away.
First Week indicator
The First Week indicator suggests that the first 5 trading days of the year will determine where the market finishes up. If the FTSE is trading higher by the end of week 1, that tells you the year will end in the blue. Simple!
The results neither support nor reject the notion. Michael Sheimo comments in his book, ‘Stock Market Rules,’ that "The indicator correctly forecast four of the eight years, where both the first week and the year-end showed similar plus or minus results."
It’s a small sample but we should really leave it at that. I’d hate to think that Michael has nothing better to do than justify these bizarre concepts.
Theo Casey
