Will a 'Sell in May' Plunge Come Early This Year?

With the Dow Jones Industrial Average (^DJI) and the S&P 500 (^GSPC) at record highs, even investors who fearfully stayed out of the market for years in the wake of the financial crisis have started inching back in. Flows of money into stock mutual funds and exchange-traded funds have risen sharply.

But the old adage that advises "Sell in May and go away" reflects a widely held view of the stock market -- that seasonal factors play a role in whether share prices go up or down. The idea behind the sell in May strategy is to buy stocks in November and hold them through the end of April, and then sell them in May and shift your portfolio into alternative investments through the end of October.

But Does It Work?

Some parts of the sell in May strategy make intuitive sense.

September and October have long been notoriously bad months for stocks, with the big stock market crashes of 1929 and 1987 having happened in October, and the 2008 market meltdown having reached an initial climax in September. Meanwhile, December and January have tended to be fairly strong months, aided by new money coming into the market from work bonuses.

But when you look more closely at the sell in May strategy, its results don't hold up.

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A 2012 study showed that the strategy returned an average of 8.3 percent annually over an 86-year span, compared to a 9.9 percent average annual return for simply owning a broad-based stock index throughout the entire period.
And then there was last year.

In 2012, stocks actually rose slightly from May 1 to October 31, with the S&P 500 providing a total return of about 1 percent. But that performance hides some important details about what happened last year.

One problem that often happens with seasonal strategies is that as they get popular, investors start anticipating their impact. That seemed to happen last year, when the Dow opened April by plunging nearly 500 points in the first ten days of the month. That was only half of the nearly 1,000 points that the Dow climbed in January through March of last year, though, and so even after a worse decline in May, the Dow never fell more than 200 points below where it started the year.

As a summer rally took hold, sell in May advocates believed that traditional weakness in the fall months might justify the strategy. But the market actually soared in September, and even a poor October showing wasn't enough to send the Dow lower.

How's This Year Shaping Up?

Investors must feel a sense of déjà vu this year, as the Dow is up an even more significant 1,450 points in the first three months of 2013. Pessimists have been calling for a pullback for months now, and the sell in May adage could become the catalyst for a correction.

The question facing investors, though, is whether May will be too late to sell.

Already, some experts have predicted a repeat of last year's April anticipatory selloff, as institutional investors who have been most interested in holding onto healthy gains through the end of the first quarter will turn their attention toward protecting their profits.

With double-digit returns constituting a solid performance for an entire year, many fund managers and other investment professionals will likely get a lot more conservative for the remainder of the year. That behavior could well set off a stock-market slide.

What You Should Do

Following various seasonal strategies has had mixed success over the years. The better way to respond to concerns about high levels for the stock market is to make sure that the risk level in your investment portfolio is appropriate for current conditions.

If your portfolio has gotten too risky, sell part of your holdings. But don't do it just because May is coming. And make sure your sales are consistent with a longer-term investing strategy that gives you the best chance for you to reach your financial goals for the long run.

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