If You Didn't Sell in May -- There's Still Hope

May's market performance was the worst since Feb. 2009
May's market performance was the worst since Feb. 2009

Hindsight is definitely 20-20, but many investors are no doubt kicking themselves for not practicing the old adage "Sell in May and go away," after May turned in the worst market performance since February 2009.

The Dow Jones Industrial Average lost 7.9% for the month, the biggest loss in the month of May since 1962. The S&P 500 dropped 8.2% in May, and the Nasdaq fell 8.3%. While May has historically been a bad month for stocks, the recent trend had actually reversed itself, according to data from Schaeffer's Investment Research.

Best-Performing Month Is April

As DailyFinance reported last month, as of the end of the first quarter, the S&P 500 recorded the third-highest average annual return in the month of April over the past five years and the second-highest returns over the last 10 years. April has been the best-performing month for the index for 30 years.

"Over the last five to 10 years, it hasn't held true," says Schaeffer's senior analyst Ryan Detrick, of the "Sell in May" adage. But he cautions that this year, investors should take heed of the market's historical weakness in June and July. The sovereign debt crisis in Europe, financial reform legislation, unresolved issues with health-care reform, tax policy adjustments, terrorism and other factors are likely to continue to contribute to an environment of volatility over the summer that will mute any market rallies in the near term.

"We expect the volatility to be with us for a while until a lot of these issues are solved, and I don't think we're close to solving them," he says.

Don't Miss the Recovery

Quincy Krosby, market strategist for Prudential Financial, has never fully bought into the "Sell in May" theory because as she says, "If you Sell in May and go away, the question is, when do you come back?"

If you had followed the adage last year, you would have missed out on one of the greatest market recoveries after a crash. For those retail investors who have already sold during May this year, it will be important for them to get back into the market in order to capture the very few days it takes for the markets to recover the ground lost during the pullback.

Krosby suggests the time to return to the market is "when you actually see 'conviction buying' picking up. When money managers have a shopping list and are buying companies for more than just a trading session."

"At some point you will see that type of buying pick up," says Krosby, "and it could happen during the summer months."

September and October

Historically, investors who sold in May tended to come back to the market in the fall when traders return from vacation, but September and October have also traditionally been two of the worst months for stock-market performance. Today, most money managers advise investors to keep a diversified portfolio when markets are volatile -- that way you spread the risk and capitalize on inverse relationships of different asset classes.

Even though there has been a significant pullback in the market and there is expectation of continued volatility, Detrick advises clients to continue buying U.S. equities. However, he suggests they also "put some money in bonds, put a little bit in gold and leave some in cash."

Compared with Europe and Asia, "the U.S. market is in better shape so we expect outperformance," Detrick says. "By the end of the year, we'll probably have low-single-digit gains."

Krosby suggests clients make sure they have exposure across all asset classes, then adopt a more active managed strategy for the remainder of the year. "Look for companies with very strong balance sheets and companies that offer healthy dividends."

Book Losses Against Capital Gains

Rose Greene, a certified financial planner for LPL Financial in Santa Monica, Calif., who started taking profits before the May sell-off, has a different approach from the "Sell in May" adage.

"If people have unrealized losses this month, I would take those losses and book them and use them against the capital gains they will hopefully experience by the end of the year," she says. Rose then advises taking the proceeds from those assets and purchasing investments that are dissimilar to the ones just sold. Then buy back into the market at different intervals on market dips.

"I wouldn't put all my money in at one time," she says. "I would also be looking at asset classes that aren't quite as vulnerable to headline news -- for example, smaller and midsize U.S. companies are not as tied into the euro and what's happening in Europe."

Positive Outlook for the Year

Greene believes the U.S. economy will struggle in the second half of 2010, but stocks will probably still end the year with net gains. However, by purchasing large-cap, dividend-paying stocks and real estate investment trusts (REITs) that must pay profits back to investors through dividends, investors can cushion their portfolios against further pullbacks.

"At least if one repositions assets where there is good income flowing in, it can make a mediocre year look a lot better," Greene says.