The Sell-in-May Mythology Just Doesn't Seem to Go Away

Investors have enough to worry about without this old saw's bad guidance.
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Worried that the stock market is entering a period of seasonal weakness? Don't be.

While there are plenty of other reasons to be cautious on stocks right now, the date on the calendar is no reason to dump your holdings.

Over the past week or so, the old Wall Street adage, "Sell in May and walk away," has been repeated

ad nauseam

, with traders warning that liquidity is about to dry up as big investors head off to the Hamptons on vacation.

Historically, the adage holds, the market has fared poorly from the start of May through the end of October and much better in the November-through-April period.

In many ways, it's a logical assumption. At the start of the year, investors are plowing Christmas bonuses into the market or contributing to 401k plans and IRAs. As the summer rolls around, however, there are fewer incentives to put cash to work.

According to the

Stock Trader's Almanac

, investors would have lost money in the market from May through October over the past 53 years. A $10,000 investment back in 1950 would be worth just $8,375 today if it were placed in the

Dow Jones Industrial Average

during seasonally weak months. If invested during seasonally stronger months, however, the investment would have compounded to $461,774.

"Since 1950, an excellent strategy has been to invest in the market between Nov. 1 and April 30 each year and then switch to fixed-income securities for the other six months," the

Almanac

declares.

Switching to bonds right now, however, isn't necessarily the best idea given expectations for a

Federal Reserve

rate hike in August. What's more, the

Almanac's

assumptions don't take into account transaction fees or taxes. Financial advisers say it's not a good idea to dart in and out of stocks because the costs associated with this strategy can quickly eat into returns.

J. Taylor Brown, vice president at the Hirsch Organization, said his firm doesn't actually sell stocks in May, but it does take profits more regularly and tightens stop losses. The Hirsch Organization is the publisher of the

Stock Trader's Almanac

.

"We use it as an indicator to trade more carefully," he said, noting that there have been periods when selling in May and returning in November hasn't worked.

Last year, for example, the

S&P 500

rose 14.6% during this period.

Bryan Olsen, vice president at the Schwab Center for Investment Research, conducted his own study on season trading patterns and found that, historically, July has been the highest returning month for the S&P 500. "So if you'd sold in May, you'd have missed almost a century of July gains," he said.

Olsen said a $100 investment in the S&P 500 at the beginning of January 1926 would have been worth $228,479 at the end of December 2003. But a $100 investment that was in the market November through April and out of the market May through October would have been worth just $59,569 at the end of the same period. These results assume the reinvestment of dividends and interest and do not account for transaction fees or taxes. The Ibbotson Associates U.S. 30-day T-bill index was used to represent time out of the market.

Olsen concedes that there are some periods where a seasonal strategy would have worked well. It certainly would have behooved investors to exit the market in the summer months of 2001 and 2002.

"Using 20-20 hindsight, we find that getting out of the market in the summer months would have benefited us particularly well in the 1970s," he added. "But we're not actually convinced that's a seasonal strategy at all, because the '70s included one of the most severe bear markets, getting out of the market and into cash would have provided higher returns regardless of the month."

Michael Panzner, author of

The New Laws of the Stock Market Jungle: An Insider's Guide to Successful Investing in a Changing World

, which is due to be published in July, said widely held perceptions about summer weakness can be a contrarian indicator for the market.

"In general, when investors are aware of such phenomena, it causes them to take action in anticipation of the expected event," he said. "When many investors are aware of such things -- as is the case now -- a curious thing happens: It often ends up unsettling the dynamic of the marketplace, and it produces a result that is contrary to expectations."

To be sure, there are legitimate reasons to be concerned about equities right now. A rate hike by the Fed would raise corporate borrowing costs and a pickup in the labor market could hurt corporate earnings, which are already expected to decelerate this year.

What's more, the market is looking shaky from a technical point of view. The

Nasdaq

fell 6.3% last week, closing below the 200-day moving average for the first time in 13 months. Investor selling has been fairly indiscriminate recently, with stocks moving down on both bad news and good. In addition, volume has been heavy, a sign that big players might be getting out.

Still, optimists say the market is starting to look oversold and may be due for a bounce. Liz Ann Sonders, chief investment officer at Charles Schwab, said that in an election year, the market usually does well from May through the end of the year.

"I don't think investors should ever listen to advice as simplistic as

sell in May and walk away," she said.