Buy and Hold or Sell in May?

May 9th, 2006 | By Penny Sleuth Contributor | Category: Investing Strategies, Macroeconomics

Hello again, Sleuths,

Four months are in the books and — seemingly against all odds — the major stock averages are all ahead for the year (at multi-year highs, in fact). Neither $75 oil, gold approaching $700, a plummeting US greenback, a president’s approval rating at new lows, soaring inflation, overseas wars with no end in sight, and 15 consecutive increases in the federal funds rate (with yet another expected tomorrow) have kept stocks from their appointed rounds of higher prices.

What are we to make of it? As a technician I can only say “the trend is your friend” and go from there.

Two weeks ago — with all of the widely followed market indices (large, mid, and small-cap) — trading higher than where they began the year, I began to investigate what implications those higher prices would have on the rest of 2006. If you recall from my last column, I concluded — after studying S&P 500 returns going back to 1970 — that based on the historical patterns of the last three-and-a-half decades, the odds favored that closely scrutinized large-cap benchmark ending 2006 in the plus column.

Now, given my forecast that this year would be a rough one for equities, that conclusion wasn’t an easy one for me to swallow. And my forecast could still turn out to be correct. But I wouldn’t bet on it. And history doesn’t support it.

So, what else can we glean from the last few decades of S&P 500 results? Is it better to buy and hold or is it more advisable to sell in May and go away?

Here’s what the historical results from 1970-2005 show. Between May and October — traditionally the slow time in the market — the S&P 500 has gained an average of 1.3%. Meanwhile, in the last two months of the year, the index has averaged a gain of 3.4%. So, based on those numbers, while you can eke out a small profit in the middle six months of the year, you can earn 2 1/2 times that amount in just November and December. And you can do it with less risk.

But wait! There’s more in those results than meets the eye. If you recall, in my last column I also raised the possibility that there is a correlation between how well the S&P 500 performs from May and October and the results the index posted in the prior four months.

So, let’s look at those historical returns again in light of whether the S&P 500 entered May on the heels of a profitable first four calendar months — as it has done this year — versus how it has performed when it’s under water come May 1.

You may be surprised to find that the “sell in May and go away” approach to investing often doesn’t work. In fact, in the years when stocks have climbed throughout the late winter and early spring, odds favor that bullish activity continuing through the dog days of summer.

Note that I said “odds.” When it comes to trading or investing, there are few, if any, absolutes. But it always helps your overall performance to tilt the odds in your favor. And that’s all we’re attempting to do by sifting through the S&P 500’s historical data.

As for those odds, let me share some interesting numbers with you. First, as I mentioned in my last Technical Tuesday column, in the period from 1970-2005 the S&P 500 turned a profit between January 1 and April 30 on twenty occasions — or 56% of the time.

Now, in that same thirty-six-year period, the S&P 500 was higher on October 31 than it had been on April 30 twenty-four times. But in those twenty years where the S&P 500 arrived at May 1 at a higher level than it had been on January 1, the index managed to notch additional gains over the next six months fifteen times — a 75% profit rate! Meanwhile, on the sixteen occasions when the S&P 500 limped into May in the red for the year, the index was able to post positive results between May and October only nine times — or just 56% of the time.

It gets even better. I said earlier that, from 1970-2005, the S&P 500 gained an average of 1.3% from May to October — not exactly a killing when you consider all the time your money is at risk. However, in the twenty years the index entered May with a profit, on average the S&P 500 picked up an additional 3.4% over the next six months — two and-a-half times better than the average return for the entire thirty-six-year study period.

Conversely, a negative start to the year has proved to be a precursor to a rough May to October period. During the sixteen years when the S&P 500 ended April down for the year, the dictum “sell in May and go away” proved to be good advice for investors — as the index averaged a 1.3% loss.

The phrase “sell in May and go away” is catchy and has — at times — saved those investors who heeded that old bromide “some money,” or at least minimized their risk. And it may prove to be a valuable piece of advice again in 2006. But like everything in the market — and life, for that matter — things are usually not quite so easy.

The bottom line is that when the market is strong you might not want to be so quick to sell in May and go away. That’s because of the other well-known market maxim I mentioned at the beginning of today’s column: “The trend is your friend.” And that’s where technical analysis comes in.

Trade well,

Mark Bail
May 9, 2006

Penny Sleuth Contributor

The Penny Sleuth also features commentary by other financial analysts, small-cap experts, investment gurus and an array of contributors from various fields and occupations. Their diverse insights and contrarian investing ideas are hand selected by the Penny Sleuth editors.

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