For decades, the idea that you should sell in May has been an important part of stock market folklore. Itâ€™s sometimes called the Halloween indicator, since you buy back in October. Of course, investing should not be that easy, but the odd thing is that, compared with other rules, this one has held up rather well over history.
This year, given high valuations there might be additional reasons to be cautious when investing over the coming months. That said, bond yields are tight too, so switching into bonds isnâ€™t quite as attractive as in past years.
Basically, looking historically over many decades, the markets have tended to return closer to 1% over the May to October period and then 5% during the winter months, on average. For most countries the data is from 1919-2017. This has been broadly true across 65 different countries where historical data is available, though apparently Mauritius is the exception where the rule doesnâ€™t seem to hold. Also, in the major emerging markets of China and India the statistical evidence is less robust but still moves in the same direction. If you look at an aggregate index of global stock markets, then the rule has historically held up on average.
Itâ€™s also important to note that this rule does not hold up each year, just on average. Also, important is the fact that even if returns are 1% over the summer months, thatâ€™s still positive. Though arguably thatâ€™s not enough compensation for the risks of being in stocks compared to other assets. Itâ€™s also important to note that often these sorts of historical rules in the stock market can change once discovered. However, up to at least 2017, this effect has remained in effect.
Should You Sell?
Short-term trading can have tax consequences. If youâ€™re trading your portfolio every six months, then that may mean short-term gains rather than long-term gains if youâ€™re in a taxable account. That could offset potential benefits even if the strategy plays out as you hope.
Challenges Of Market Timing
Also, selling stocks can often be easier than buying back in. It can be easy to find a reason to leave the market, but having the courage to buy back in may not be as easy and can be just as important. There are always reasons to worry in the market, but often these donâ€™t blunt the marketâ€™s general ability to deliver returns over history. Thereâ€™s a risk you end up out of the markets for longer than you expect.
Also, what to switch into? Say the markets deliver 1% over the summer months, bonds arenâ€™t offering much more, though are potentially more stable. Unlike in past years bonds returns are looking potentially less attractive. Generally, cash doesnâ€™t offer attractive returns, so staying in cash for too long can see the value of your savings eroded by inflation.
Sell This May?
So thereâ€™s a reasonable chance, if history is any guide, that returns over the coming months may be more muted than in the past months. In fact, given the blistering returns to stocks coming out of the pandemic, thatâ€™s not much of a prediction. Now is perhaps a good time to assess your portfolio exposure and see if the run up in stocks has left you with a higher weight in stocks than perhaps you planned for. Trimming in May may be an easier move than wholesale moves for your portfolio.
Both elevated valuations and the sell in May effect suggests that going forward returns could be somewhat lower than weâ€™ve seen in the past. That said, the stock market has still been a good place to invest over the longer term and market timing can be fraught with issues.
Simon is the author of Digital Wealth and Strategic Project Portfolio Management. He has previously served as Chief Investment Officer at Moola and FutureAdvisor, both
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