How To Play "Sell in May"

Safe "Sell in May" Plays

Written by Adam English
Posted May 14, 2013

In a cruel twist of fate, just as the temperature begin to warm up and the drab concrete of Baltimore's streets are enlivened by a lush green canopy... the financial world withers and goes dormant.

The good news is we may finally see a break from the pattern. We're well into May now, and there seems to be a good chance that the traditional "sell in May" may never materialize. I'm sure nobody would complain, but I wouldn't celebrate just yet...

The history of the seasonal market cycles runs into the dawn of history — at least, for the financial world.

Ben Jacobsen, a finance professor in New Zealand, studied all available historical evidence from 108 different stock markets around the world. His statistical tests detected the seasonal pattern in the United Kingdom stock market as far back as 1694. Jacobsen even managed to find a Financial Times article dating to 1935 that refers to the "sell in May" pattern and implies that it was well-established with market watchers, investors, and financiers.

On the domestic front, last year saw a 11.5% gain between late October and early May. The rest of the year posted a 0.9% loss. And over a fifty-year timespan, the cycle averages out to a gain of 7.5% and a 0.1% loss over the same time periods.

Here is a look at how a single dollar would grow if it were invested in just one of the six-month blocks each year:

sell in may dollar growth

What to Expect

I have a strong hunch that 2013 will beat the historical average and become a rare year in which we see positive gains during the May to October cycle. However, I think it will generally conform with the historical data.

This isn't breaking the trend; we are still going to go through a kind of winter for investing. It will just be an unseasonably warm one.

We have seen a pretty hefty rally in the markets so far, and on the surface, the engine seems to be running rich and ready to sputter. A big part of that sentiment is coming from the constant barrage of headlines regarding all-time highs in the Dow and S&P 500 indices. Stare at those long enough, and you'll start believing we're at perilous heights, looking at a long way to go down.

The S&P 500 has posted massive gains, no question about that: Since March 2009, the S&P has posted an annualized 26.2% gain. That matches the rise in the index in the 50 months leading up to the tech bubble's burst.

However, all of this clamor is about nominal highs — not the real inflation-adjusted values that should be used.

Valuation of the S&P 500 puts the index 28% lower than the peak of the rally in the late 1990s. Shares are trading at an average of 18.5 times annual profit, as opposed to a 25.7 multiple we saw back then.

s%26p500 nominal vs. adjusted

We are in an environment where caution is warranted. I fully expect the broader market to gain value at a much slower rate, but I don't see much pressure on traders to sell off en masse and run.

Nonetheless, a slow summer calls for a different approach, and we all know the market is prone to irrational sell-offs...

The free market doesn't care if we make it past an arbitrary cut-off date in two and a half weeks.

Now is a great time to get your portfolio in a position where the gains from winter are protected — and where you can pull in some profits you can use in the last couple months of the year.

Getting Defensive with the Right Sectors

If you take thsell in may sectorse time to dive a little deeper into the numbers, you quickly start to see that all things are not correlated in the summer financial doldrums. Overall returns may not be anywhere near as stellar, but a handful of sectors consistently out-perform the rest.

Even better, these sectors host a large number of dividend-paying companies that will boost returns above basic share price gains or losses. They'll also show more resiliency as part of a defensive portfolio, if and when the masses decide it's time to get out of the markets.

MarketWatch put together a great table of individual sectors and how well they do during the lean summer months, which you can see to the right.

A full 80% of the time, when the S&P 500 was up in the first couple months of a year, the utilities, telecom services and health care sectors trumped the total index and saw gains over 7%. This has happened 10 times in the last 23 years, and we definitely saw it this year.

If your funds are parked in a mutual fund, or if you're lacking the time or patience to handle individual stocks, You can easily invest in these sectors as a whole to set yourself up for a strong year of gains...

Check out the SPDR Health Care Select Sector ETF (NYSEARCA: XLV) and the SPDR Consumer Staples Select Sector ETF (NYSEARCA: XLP).

Utilities and telecom companies are good choices as well, but health care and consumer spending are going strong and steady. Both are forecast to grow as the economy slowly heats up, and these ETFs have stakes in consistent and solid companies.

There are other options out there as well, but none are anywhere near as large. The extra liquidity will make moving in and out easier, if and when the time comes.

Of course, both have been so good over the long term that you might just want to consider using them over a mutual fund or broader index:

sp500 vs. xlv and xlp

Speaking of health care and at the risk of jumping the gun, the Outsider Club's Nick Hodge has been doing the due diligence for a new health care investment opportunity that uses an incredibly unique angle.

He blew me away when he told me about it.

Rest assured, you'll be hearing about this very soon from him...

Take Care,

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Adam English for Outsider Club

Follow Adam on Twitter through @AdamEnglishOC

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