Will a 'Sell in May' Plunge Come Early This Year?

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Traders work on the floor of the New York Stock Exchange before the opening bell in New York City.  (Photo by Mario Tama/Getty Images)
Mario Tama, Getty Images
With the Dow Jones Industrial Average (^DJI) and the S&P 500 (^GSPC) at record highs, even investors who fearfully stayed out of the market for years in the wake of the financial crisis have started inching back in. Flows of money into stock mutual funds and exchange-traded funds have risen sharply.

But the old adage that advises "Sell in May and go away" reflects a widely held view of the stock market -- that seasonal factors play a role in whether share prices go up or down. The idea behind the sell in May strategy is to buy stocks in November and hold them through the end of April, and then sell them in May and shift your portfolio into alternative investments through the end of October.

But Does It Work?

Some parts of the sell in May strategy make intuitive sense.

September and October have long been notoriously bad months for stocks, with the big stock market crashes of 1929 and 1987 having happened in October, and the 2008 market meltdown having reached an initial climax in September. Meanwhile, December and January have tended to be fairly strong months, aided by new money coming into the market from work bonuses.

But when you look more closely at the sell in May strategy, its results don't hold up.
A 2012 study showed that the strategy returned an average of 8.3 percent annually over an 86-year span, compared to a 9.9 percent average annual return for simply owning a broad-based stock index throughout the entire period.
And then there was last year.

In 2012, stocks actually rose slightly from May 1 to October 31, with the S&P 500 providing a total return of about 1 percent. But that performance hides some important details about what happened last year.

One problem that often happens with seasonal strategies is that as they get popular, investors start anticipating their impact. That seemed to happen last year, when the Dow opened April by plunging nearly 500 points in the first ten days of the month. That was only half of the nearly 1,000 points that the Dow climbed in January through March of last year, though, and so even after a worse decline in May, the Dow never fell more than 200 points below where it started the year.

As a summer rally took hold, sell in May advocates believed that traditional weakness in the fall months might justify the strategy. But the market actually soared in September, and even a poor October showing wasn't enough to send the Dow lower.

How's This Year Shaping Up?

Investors must feel a sense of déjà vu this year, as the Dow is up an even more significant 1,450 points in the first three months of 2013. Pessimists have been calling for a pullback for months now, and the sell in May adage could become the catalyst for a correction.

The question facing investors, though, is whether May will be too late to sell.

Already, some experts have predicted a repeat of last year's April anticipatory selloff, as institutional investors who have been most interested in holding onto healthy gains through the end of the first quarter will turn their attention toward protecting their profits.

With double-digit returns constituting a solid performance for an entire year, many fund managers and other investment professionals will likely get a lot more conservative for the remainder of the year. That behavior could well set off a stock-market slide.

What You Should Do

Following various seasonal strategies has had mixed success over the years. The better way to respond to concerns about high levels for the stock market is to make sure that the risk level in your investment portfolio is appropriate for current conditions.

If your portfolio has gotten too risky, sell part of your holdings. But don't do it just because May is coming. And make sure your sales are consistent with a longer-term investing strategy that gives you the best chance for you to reach your financial goals for the long run.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the free report: "The Motley Fool's Top Stock for 2013."

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Philo

I had a friend who got involved in investing. He got pretty good at knowing when to buy and when to sell, and I always used to laugh when he would say... This stock or that stock was going to be like a chicken without a head. the trick was to know when the head was going to be chopped off. While he did pretty good, there was one time that almost put him in the poor house. Stock market is like legal gambling, and if you are not careful you can lose a lot of money, or make a lot of money. Hey look at the crash of 1929...

April 01 2013 at 1:22 AM Report abuse rate up rate down Reply
FITNESSMAXX

Cash is King right now. Market ready for a healthy correction. We had a good run, but these highs are out of touch. Remember Joe Kennedy.

March 31 2013 at 8:52 PM Report abuse -1 rate up rate down Reply
rkeeeballs

No matter ...hold the coarse. Been on quality issues ,and have held on through all the ups and downs.......Doing fine !....People will still and always buy life's staples...food...gas...insurance.. cars...homes...bathroom products...ect...ect...if inflation were to be counted , the market is at, or below where it should be.......It's not over priced.

March 31 2013 at 12:41 PM Report abuse +1 rate up rate down Reply
rbearland

If you dump out, then where are you going to put it? With saving interest so low I think we'll see more folks going to the market with their cash to get 4+% returns with reasonable capital gains for another year. How about them apples Rhoda?

March 31 2013 at 10:13 AM Report abuse +1 rate up rate down Reply
mrbasebal1

Of course there will be a massive correction. The only question is: When?

March 30 2013 at 2:56 PM Report abuse -1 rate up rate down Reply
ccdae5

I'm ready to dump at a moment's notice!

March 30 2013 at 8:09 AM Report abuse -1 rate up rate down Reply