The Capricorn Effect and May Sell-off

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#71
Seemed like buy and hold still outperform the season effect

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Should You Sell in May? Read This First

By Alex Dumortier | More Articles
April 30, 2012 | Comments (42)

Around this time of year, pundits and commentators invariably trot out the recommendation to "sell in May and go away," on the basis that returns from May through September have historically been awful relative to those earned during the complementary months. There is no shortage of folk tales in investing, so in the spirit of a superb book I'm currently reading -- Expected Returns by Antti Ilmanen -- I thought I'd listen to the data instead. Before you liquidate your stock portfolio, I recommend you review my findings below.

We're off to the races!
First, a bit of market history: "Sell in May and go away" did not originate on Wall Street, but rather in the City, London's financial district. In fact, the full saying is "Sell in May and go away; come back on St. Leger's Day." The St. Leger Stakes is the oldest of England's five horseracing classics and is the last to be run.

As far as I know, the data that are most widely cited by investors and brokers regarding this phenomenon are that of Ned Davis Research (not so for academics -- the seminal paper in that realm is Bouman and Jacobsen's The Halloween Indicator (link opens PDF file).) The following table contains one of NDR's findings regarding the S&P 500 (INDEX: ^GSPC ) :

Current Value of $1,000 Invested in the S&P 500 Beginning on April 30, 1950*

Sell in May, buy back in October
$75,539

Buy in May, sell in October
$1,032

Source: Ned Davis Research. *At March 31, 2012, does not include dividends. **Money is invested in stocks from Sept. 30 through April 30 annually and is in cash (no yield) during all other periods.

The numbers certainly look impressive: Stocks' price appreciation occurred almost exclusively (on average) during the period October through April. By comparison, holding stocks from May through September appears to have barely preserved the nominal value of the initial investment over a 62-year period!

Hold on
I'm perfectly willing to believe that there is a seasonal component to stocks' price appreciation that is inconsistent with efficient markets, but these data aren't enough to judge the efficacy of a seasonal switching strategy. In that regard, NDR's methodology suffers from several shortcomings: For one, it assumes that when the money isn't invested in stocks, it earns no return whatsoever instead of being invested in Treasury bills. Furthermore, their data do not account for dividends, a critical component of stock returns. Finally, there is no benchmark data corresponding to a straightforward "buy and hold" strategy.

The numbers
In order to address these issues, I performed my own calculations, using data series from Ibbotson Associates (a unit of Morningstar) that begin in 1926. The following table contains the results of my analysis:

S&P 500: Annualized Return (including dividends)

April 30, 1926 to March 31, 2012

Sell in May, buy back in October 8.4%
Buy in May, sell in October 5.1%
Buy-and-hold 10.0%

Source: Ibbotson Associates, Standard & Poor's, Federal Reserve Bank of St. Louis, author's calculations.

And your winner is...
There are two key observations here:

The "sell in May" strategy soundly beat the converse strategy, with a margin of outperformance that exceeds 3 percentage points on an annualized basis.

However, "Sell in May" underperformed buy-and-hold; in fact, the outperformance of buy-and-hold is understated because the returns in the table assume no transaction costs and no tax impact. Investors selling in May incur taxes on short-term capital gains and higher transaction costs than their buy-and-hold counterpart.

About the same
If you're clinging to the notion that "sell in May" could yet be superior to buy-and-hold on a risk-adjusted basis, you should know that both strategies have identical Sharpe ratios of 0.12 (the Sharpe ratio measures the incremental return that an asset or strategy generates per unit of volatility). That's not surprising, given that depending on where you are in the calendar, "sell in May" is either equivalent to buy-and-hold or simply earning the risk-free rate.

I think it's quite likely there is a seasonal effect to stock price appreciation that is more than simply a spurious historical observation. However, that's far from enough justification for reducing (much less eliminating!) one's exposure to stocks as May rolls in. The primary consideration when deciding one's allocation to stocks should be valuation, not the date on the calendar.

Overvalued stocks
Right now, U.S. stocks look at least somewhat overvalued, based on the Shiller P/E, which uses a trailing 10-year average of real earnings. Furthermore, I think we can expect a change in volatility regime as the year unfolds, with the exceptional uncertainty linked to the European sovereign crisis simply biding its time to manifest itself. As such, an underweighting in U.S. stocks is prudent for those whose equity exposure is in index funds such as the SPDR S&P 500 ETF (NYSE: SPY ) or the Vanguard S&P 500 ETF (NYSE: VOO ) . Investors who buy individual stocks based on a bottom-up fundamental analysis, on the other hand, need not be concerned. If you're in the latter camp, I recommend you take a look at "The Stocks Only the Smartest Investors Are Buying.

http://www.fool.com/investing/general/20...first.aspx
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#72
If one is not intending to purchase or do some spring cleaning of one's portfolio, it may be best not to look too much at the daily stock prices lest one is tempted to sell at the trough. The market may continue to fall but it cannot go on indefinitely. The world is awash with cash and I can't see any other place where people can put their money into which gives some decent returns, especially in these inflationary times. The smart money will come back. Patience, perseverance and courage to all reading this!
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#73
There's always property.

I always feel Singaporeans are much more likely to put their money into property rather than shares.

This is anecdotal evidence gained from just asking around.
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#74
(19-05-2012, 04:11 PM)shanrui_91 Wrote: Seemed like buy and hold still outperform the season effect

I completely forgot about that!
Thanks for pointing out.

I calculated the p.a. return on the seasonal effect- comes out to about 7.6% p.a. over the 50 year period. Looks like buying and holding from 1 Nov - 30 Apr may not be the best strategy after all.

Question: How about Buy and Hold but buying only in the traditionally (as seen from the data) weak returns season of May-Oct?

Of course, this applies only to the S&P500 as an index. It probably vary for the STI, not to mention individual stocks.
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#75
Hmm...

I thought value investing is about bottom up analysis of a company's fundamental value.

Buy when the market give us a margin of safety, and sell when it's fully or over valued? (Or no selling plan?)

I guess most can't help do a bit of "trading" around our core positions to spice things up a bit Wink

It's hard to be a purist.

What has calender effect got to do with the fundamentals of a company? Market psychology? Now that's better handled by Technical Analysis Wink
Just google singapore man of leisure
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#76
(20-05-2012, 10:00 PM)Jared Seah Wrote: Hmm...

I thought value investing is about bottom up analysis of a company's fundamental value.

Buy when the market give us a margin of safety, and sell when it's fully or over valued? (Or no selling plan?)

I guess most can't help do a bit of "trading" around our core positions to spice things up a bit Wink

It's hard to be a purist.

What has calender effect got to do with the fundamentals of a company? Market psychology? Now that's better handled by Technical Analysis Wink

haha, you are right. it's pretty easy to deviate from the path once in a while. guess i need to force myself to reread the intelligent investor once every 3 months.

valuation is what that ultimately counts when selecting the right stocks. However, portfolio allocation is another fine art that's hard to master. to have spare cash when stocks are cheap is not an easy feat
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#77
(20-05-2012, 10:00 PM)Jared Seah Wrote: What has calender effect got to do with the fundamentals of a company? Market psychology? Now that's better handled by Technical Analysis Wink

Let me try to explain..

When and if the 'calendar effect' affects the market ie. Market gets real bullish in May, then prices gets chased up. As a Value Investor, you'd have computed your own 'Intrinsic Value' and 'Margin of Safety'. Once this 'Intrinsic Value' is exceeded by a good enough margin, then SELL! Conversely, if and when the market gets real bearish by October, then BUY cos' you're getting a good enough 'Margin of Safety' to your 'Intrinsic Value'.

Easy? The problem is how to compute the 'Intrinsic Value'.. Hee... Big Grin
Luck & Fortune Favours those who are Prepared & Decisive when Opportunity Knocks
------------ 知己知彼 ,百战不殆 ;不知彼 ,不知己 ,每战必殆 ------------
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#78
(20-05-2012, 10:26 PM)KopiKat Wrote:
(20-05-2012, 10:00 PM)Jared Seah Wrote: What has calender effect got to do with the fundamentals of a company? Market psychology? Now that's better handled by Technical Analysis Wink

Let me try to explain..

When and if the 'calendar effect' affects the market ie. Market gets real bullish in May, then prices gets chased up. As a Value Investor, you'd have computed your own 'Intrinsic Value' and 'Margin of Safety'. Once this 'Intrinsic Value' is exceeded by a good enough margin, then SELL! Conversely, if and when the market gets real bearish by October, then BUY cos' you're getting a good enough 'Margin of Safety' to your 'Intrinsic Value'.

Easy? The problem is how to compute the 'Intrinsic Value'.. Hee... Big Grin

Ya lol! everyone may have different "intrinsic value". some by special formula, some by simple mathematics, and some by...?? And the worst is intrinsic value keep on changing due to many factors. Some factors may be unknown to you at that time. They say you can never know everything about a company, so its real intrinsic value. And this is also why the market exists. IMHO.TongueBig Grin
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.
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#79
Thanks for taking my gentle "poke" in the right spirit!

Sweet dreams!
Just google singapore man of leisure
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#80
Having lost its way for the past 2 days, the market is finally going the right direction
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