Alpha Power Investing Newsletter

May 1, 2014

Sell in May ... Again

All of Alpha's equity programs utilize - in one form or another - the risk management tool of avoiding stock market risk during the summer months. The Seasonal Strategy exits the market at the end of April, with the exception of presidential year three. Likewise, The Formula stays fully invested throughout presidential year three, while avoiding summer months through the rest of the four-year election cycle. The Mid-Cap strategy exits the market at the end of May and re-enters in late-October every year.

Obviously, we believe that the period from late-October through mid-May delivers higher returns with lower risk than the rest of the year. We look upon this as a high probability over multi-year stretches, not as something that appears with predictable regularity. Our research shows that the market is up 56% of the time between May and November (since 1949) with a slightly negative bias over time. Most importantly, this period has historically contained about 80% of stock market declines, including the worst parts of multi-year bear markets. 2008 was a perfect example of this tendency.

Our view is that this phenomenon is caused by the annual "forecasting cycle". This refers to the end-of-year forecasting for the next calendar year undertaken by legions of Wall Street analysts who attempt to predict earnings for the companies that they follow. These predictions are routinely too optimistic, which causes investor optimism to rise late in the year and early the next year. These estimates are subject to revision as the year unfolds, often producing a letdown in investor sentiment.

If we are correct, this pattern represents a basic human behavioral phenomenon which should occur in all stock markets which have wide public participation and established investment infrastructure.

In 2010, two researchers from the University of Groningen (Netherlands) published a paper which supports our view. They looked at 19 developed markets to determine whether market returns (appreciation only) were greater from November to May (then holding treasury bills or riskless securities) than a traditional buy-and-hold strategy. Their results also include a look at volatility (standard deviation) for both strategies.

As you can see, in every instance, the sell-in-May strategy yielded higher returns with less volatility. In eight instances, the mean returns of the sell-in-May strategy were more than double the returns of buy-and-hold, while being exposed to risk just half the time. This study confirms earlier studies of this global phenomenon.

The stock market is cyclical and unpredictable in the details of its volatility year by year. At the same time, there are meaningful patterns, caused by human behavior in reaction to repeating investment factors, which provide a method for investors to mitigate risk and improve returns over the long-term. Sometimes it's a source of frustration when the seasonal discipline causes investors to miss a robust summer, but it all comes together over a complete market cycle.

The current market cycle is half-done. Investors are happy. Sell-in-May could be the ticket for the summer of 2014.

Sincerely yours,

Jerry Minton, Ph.D.
President
1-877-229-9400, Ext. 11

Disclosure: Past performance is not a guarantee of future performance.

 
© 2014 Alpha Investment Management, Inc.
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