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Should you sell in May and go away?

The old adage is to “sell in May and go away,” but is there any sense to it?

Well, it has to be said that since 1984, the worst two six-month holding periods would have been, on average, May to October and June to November. Business journalist Peter Wells tweeted the image below this morning, demonstrating that May has been a poor month for the ASX over the last five years, and that the average over the last 20 has been a loss of almost 1%.

Source @_PeterWells

As Mike Taylor pointed out in the May 2013 Slice of Pie Newsletter, if you had invested $10,000 in the Dow Jones Industrial Index in 1950 only from May 1 to October 31 each year, you would have actually made a loss. In comparison, $10,000 invested only between November 1 and April 30, you would have made over $940,000. Remaining fully invested would have resulted in a gain of about $650,000. Furthermore,  Professor of Finance Ben Jacobsen – who has studied the phenomenon – says that investors earn much better returns investing during northern hemisphere winters. He says this holds true over a long period of time, and in almost all markets. The earliest reference to this so-called “Halloween effect” is said to have been in The Financial Times in 1964.

Having said that, I’m still not convinced selling in May is necessarily a good idea. US Fool Alex Dumortier performed his own analysis back in 2012, using data from the S&P 500 Index and including dividends. The following table contains the results of his analysis:

S&P 500: Annualized Return (including dividends)

April 30, 1926 to March 31, 2012

Sell in May, buy back in October 8.4%
Buy in May, sell in October 5.1%
Buy-and-hold 10.0%

Source: Ibbotson Associates, Standard & Poor’s, Federal Reserve Bank of St. Louis, author’s calculation

My view is that if you have a great company that you think is undervalued, you’d be crazy to sell just because it’s May. For example, if you had sold Vocus Communications Limited (ASX: VOC) in May 2013, then bought in October, you would have missed out on a gain of over 25%, and if you had done the same with TPG Telecom Ltd (ASX: TPG) you would have missed out on a gain of over 20%, including dividends. On top of that, you’d have paid your broker twice (for no gain).

Foolish takeaway

As Warren Buffett says, be fearful when others are greedy, and greedy when others are fearful. To my mind, the “sell in May” phenomenon is a great time to try to buy those companies that you want to buy, but are currently too expensive. Nothing is guaranteed, but as we go into the time of year that is most likely to see the market sell-off, it can pay to have a list of (currently too expensive) companies that you would love to own. These blue-chip stocks and these solid growth stocks are a good place to start. My advice is to be patient if you see heavy selling. To quote Motley Fool analyst Matt Joass, “Don’t buy until you can see the whites of their eyes!”

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Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Vocus Communications and has an indirect interest in TPG Telecom.

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