Alpha Power Investing Newsletter

June 1, 2020

Four Good Reasons to "Sell in May"

In the long run, no one "predicts" their way to investment success. In the end it is not about "knowing what is coming next" but about "being prepared for whatever comes next." Historically, the end of May marks the end of the typical "favorable" period for stocks which begins on November 1 of each year. Needless to say, due to the coronavirus-induced panic, the "favorable" period was not at all favorable for stock investors this time around. Understandably, different investors have reacted in different ways to recent events. But in the end, investors who have a well thought-out and diversified investment plan - and who stick to their plan - are the ones that will ultimately come out ahead. With the unfavorable "dead zone" months of June through October directly ahead, it may be time for investors to make sure they have some form of "defense" built into their overall investment strategy.

In this month's newsletter we will highlight four reasons why this might be a good year to be prepared to "play defense" during the dead zone.

#1. June through October is Overdue for a Whack
Ironically, the dead zone months of June through October have not been so dead in recent years with the S&P 500 Index showing a gain during this period in eight of the past ten years. Unfortunately, this can trigger in investors the "maybe this doesn't work anymore" reaction. But the reality is that historically the stock market routinely performs well during the dead zone for a number of years and then suffers nothing less than devastating declines.

Figure 1 displays the cumulative percent price gain for the Dow Jones Industrial Average during the months of June through October since 1950. Note the vertical red bars that highlight the peaks of previous such periods. Then consider very carefully what happens during the dead zone in subsequent years. Past performance never guarantees future results, but the results displayed in Figure 1 suggest that dead zone performance is due to "revert to the mean", i.e., witness some very bad market performance in the years ahead.

#2. The Current Trend in Price
Figure 2 displays four major market indexes, each with their respective 200-day moving average also plotted. When an index is below its 200-day moving average and especially when that moving average has rolled over and is trending lower, it is appropriate to objectively identify the "trend" for that index as bearish. Overall, the current trend is mixed. The NASDAQ 100 is above its 200-day moving average and the 200-day moving average is rising. The S&P 500 Index is also trying to follow suit. The bad news is that the Dow Jones Industrial Average and the Russell 2000 remain below their respective 200-day moving averages AND those averages have rolled over and are trending lower.


The hope is that the NASDAQ 100 will lead the other indexes and that they will turn higher as well. And that is absolutely a possibility. But investors should keep a close eye on the trend of these indexes in the days, weeks and even months ahead. As we will see in a moment, when the S&P 500 Index is below its 200-day moving average between June and October the market has lost money overall. Again, this does not mean the market will lose ground in the months ahead, but it does argue that a higher degree of caution is in order.

#3. Combining Seasonality and Price Trend Together
Figure 3 displays the cumulative % price return for the S&P 500 Index based on two simple indicators:

  • During the months of November through May the "Seasonal" trend is favorable.
  • If the S&P 500 Index daily close is above its own 200-day moving average then the "Price" trend is favorable.

On any given day both, either or none of the indicators can be favorable.

As you can see in Figure 3, the market makes most of its gains when the calendar is between November and May AND the S&P 500 Index is above its 200-day moving average. After May 31 of this year, if the S&P 500 Index is below its 200-day moving average, "Neither" of the factors will be favorable. While this would not preclude the market moving higher it would provide a definite interim warning sign for investors.

#4. Dead Zones after Down Power Zones
Here let's reiterate what we highlighted last month, as it remains extremely relevant. For the purposes of our test, we break the year into two six-month periods and look at the performance during these two annual periods going back to 1900. For the purposes of this test the six "Favorable Months" extend from November 1 through April 30 and the six "Unfavorable Months" extend from May 1 through October 31. Next, we look at how the Dow performs during the "6 Unfavorable Months" ONLY during those years when the Dow finished the "6 Favorable Months" with a loss.

The results of this test appear in Figure 4. When the six Favorable Months showed a loss, the Dow during the subsequent six Unfavorable Months lost ground 56% of the time with an average loss of -3%. The cumulative result was a loss of -79.7%.

There are several positive things in the market's favor at the moment. First, we are in a presidential election year, which tends to be favorable for stocks. In addition, the market has staged a very strong rally off of the March coronavirus-induced low, which many pundits argue is the start of the next bull market. So, there is no reason that stocks can't work their way higher in the months ahead. But, as we intimated at the outset, an investor's primary job is not to "predict" what is coming next, but rather to be prepared to take whatever offensive or defensive measures are required next.

If a retest of the March 2020 lows is in the cards, the decline could be swift and severe when it comes. On a more positive note, a successful retest of the recent lows could well set the stage for a very strong advance towards the end of the year. In the meantime, given the uncertainty surrounding the U.S. and world economy moving forward - and the factors detailed above - investors may be wise to retain a cautious stance in the months directly ahead.

Jay Kaeppel
Director of Research

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in the charts above do not represent actual trading and are not representative of the returns of any strategy. The illustrations are designed to quantify the effect of certain time periods on the Dow Jones Industrial Average, S&P 500, NASDAQ 100 and Russell 2000 as specified. Indexes are not investment vehicles and persons cannot invest directly in an index. Index funds and ETFs may vary somewhat from index returns due to management fees and portfolio structure. The data used to construct the illustrations were obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.

The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security. Before investing in any fund and/or strategy, investors should consider the investment objectives, risks, charges and expenses of the fund/strategy and its investment options.

Alpha Investment Management, Inc. is a SEC registered investment advisor located in the State of Ohio. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

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