How True Is the "Sell in May and Go Away" Adage?

By Sasha Cekerevac for Investment Contrarians

As the S&P 500 enters the month of May, many people are worried about their investment strategy, especially in light of the old saying “sell in May and go away.” Does this saying hold any value?

Let’s look at the question from two angles: a historical context and the S&P 500’s currently position.

There are some historical facts that raise a few concerns in my mind regarding an investment strategy in the market during the month of May and early summer—not only in terms of actually selling off, but also in terms of increasing volatility.

A look at the best and worst performances for the month of May since 1928 by Bespoke Investment Group, LLC shows that for the S&P 500, two of the top-10 worst Mays (May 2010 with a 8.2% contraction, and 2012 contracting by 6.27%) and one of the top-10 best Mays (May 2009 with 5.31% growth) occurred during the recent bull market that started in 2009. (Source: “S&P 500’s Best and Worst Months of May Since 1928,” Bespoke Investment Group, LLC web site, April 30, 2013, last accessed May 1, 2013.)

Clearly, volatility in the S&P 500 has increased substantially for the month of May for the past few years over the course of the current bull market, and your investment strategy certainly needs to take that volatility’s timing into account. Additionally, since the bull market’s beginning in 2009, the S&P 500 during the month of May has averaged a decline of 2.64%.

Looking even further back, many investors have continued to alter their investment strategy for the S&P 500 during the month of May—and the spring season in general—since history does indicate that caution is warranted during this timeframe. Mark Hulbert of MarketWatch stated on CNBC that statistical work has shown the “sell in May and go away” trading strategy has worked since the 17th century. (Source: Navarro, B.J., “‘Sell in May,’ History Says: Pro,” CNBC.com, April 30, 2013, last accessed May 1, 2013.)

Hulbert states that statistical work on 108 different stock markets, going back as far as England in 1694, shows some evidence that indicates that selling in May through October has some merit. However, not all stocks within the S&P 500 are affected. The investment strategy for certain sectors was more positive historically than others.

Of course, one can’t make a decision on an investment strategy simply based on past performance. We all know that past performance is not always a predictor of the future. However, there are persisting worrisome signs that the S&P 500 is due for a pullback in the current timeframe.

Featured below is a chart for the S&P 500 and the Dow Jones-UBS Commodity Index:

Chart courtesy of www.StockCharts.com

This chart, showing the S&P 500 and the Dow Jones-UBS Commodity Index, indicates that while there were obvious deviations over the past 10 years between the S&P 500 and the commodity index, the divergence has now really become quite large. In addition, the relative strength index (RSI) for the S&P 500 has now moved into overbought territory.

However, there are additional variables to consider when making any shift in an investment strategy. At this time, we’re seeing aggressive central bank stimulus around the world. This might drive the commodity prices higher, closing the gap while leaving the S&P 500 relatively untouched.

Considering the relative calm and low volatility levels in the S&P 500 over the past couple of months, it makes sense to take precautions in your investment strategy and prepare for higher volatility levels. Low volatility levels can only last for so long before a spike occurs.

Given the economic situation in America—and around the world—if I were currently holding stocks in the S&P 500 that are up significantly, I would certainly look to take profits. The increase in the S&P 500 since November of 2012 cannot continue at the current pace. My personal investment strategy would be to begin raising cash or possibly buying puts to hedge my portfolio.

This article How True Is the “Sell in May and Go Away” Adage? was originally published at Investment Contrarians