Sunday, June 24, 2007

Sell in May and Go Away

The 2% drop in the S&P500 last week brings to mind the old Wall Street aphorism - "Sell in May and Go Away." The assumption behind the saying is a solid one -- the summer action in the markets is generally unproductive for investors. Recent academic studies lend credence to this saying.

A small study I did for the 14 years from 1994 through 2004 yielded the following monthly average returns for the 10 largest Northern Hemisphere stock markets:
When you look out further in history, as the authors (Ben Jacobsen and Sven Bouman) of an excellent 2001 study have done, the data supports the "Sell in May and Go Away" pattern: "Surprisingly, we find this inherited wisdom to be true in 36 of the 37 developed and emerging markets studied in our sample. The 'Sell in May' effect tends to be particularly strong in European countries and is robust over time. Sample evidence, for instance, shows that in the UK the effect has been noticeable since 1694." The study shows that, on average, a buy-and-hold investor would do approximately as well as a "Sell-in-May-and-Go-Away" investor (holding stocks from November 1st to April 31st).

Other researchers have theorized that this effect is biological in origin. In the paper "Winter Blues: A SAD Stock Market Cycle" the authors find that the seasonal effect is more pronounced at higher latitude stock markets (such as Stockholm) where sunlight waxing and waning is more pronounced, and it is inverted in Southern hemisphere stock markets (such as Sydney) where seasons are reversed. In fact, a Stockholm to Sydney portfolio rotation (to match the late Fall to early Spring cycle) earned over 20% annually. Investing in each market (Stockholm or Sydney) alone throughout the year earned about 13%. The authors point out that "Seasonal Affective Disorder", a type of depression that is most pronounced in the late summer and early fall, has a similar cycle as the stock market.

In a more recent 2005 study, the seasonal effect was found to be pronounced worldwide in IPOs and earnings revisions, as if investors' expectations become overly optimistic during the Fall and Winter and then come back to reality in the Summer. This hypothesis of optimism fits with the biological hypothesis, as increased optimism is a hallmark of increased seasonal serotonin and dopamine levels in the brain.

All of these studies indicate that the old aphorism may really be true. Summer is an excellent time for reflection and research, and it will only rarely be a peroid of high returns.


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