It may not rhyme, but “Sell in May, and then take your investing materials to the beach” is good advice. Copyright (c) <a href='http://www.123rf.com'>123RF Stock Photos</a>

There’s an old investing bromide – one that most investors have never heard of, but occasionally gets dusted off this time of year – that goes “Sell in May, and then go away.” The idea is that the majority of stock increases happen over the winter months, and then the market stays pretty sleepy from May through September or October. With the S&P 500 up by more than 10 percent year-to-date, it might make sense to expect the market to go into hibernation for a while now.

The strategy certainly would have worked last year. By May 1 of 2011, the S&P 500 was up a solid 8.2 percent on the year. By the beginning of October, though, the index had fallen nearly 20 percent from where it had stood on May 1st. But that didn’t have anything to do with selling in May, of course. The market mostly held its ground through the spring and early summer before collapsing in late July and early August.

In 2010, though, there really was a significant sell-off in May. That year, the S&P finished off April at 1186, but was down to 1070 by the first of June, a loss of nearly 10 percent of the market’s value in a single month. And the S&P didn’t fully recover from that loss until after Labor Day.

So that’s two straight years in which taking the summer off from one’s equity investments would have been a very good thing. How long does this trend hold up? Let’s take a step back and take a longer view.

Analysts at Zacks Investment Research have looked at this issue going back to 1950, and found that there may be something to the idea of selling in May. Zacks’ research found that the Dow Jones industrial average has returned a microscopic 0.4 percent from May to October. By contrast, those same Dow Industrials have returned an average of 7.4 percent from November to April. (All figures are since 1950.)  The S&P 500 shows a similar effect. According to research provided by Standard & Poor’s, their flagship stock index rises an average of just 1.3 percent from May 1 through October 31.

So something real is happening here. There are many theories as to why, beginning with the fact that many investors, including lots of people who work on Wall Street, take vacations in the summer and are inclined to make significantly fewer trades. But a reduction in volume, while it is likely to bring an increase in volatility, does not necessarily mean a reduction in stock prices. And most of us don’t have the wherewithal to spend three full months on vacation.

There’s also the theory that people tend to get financial windfalls in the springtime, like year-end bonuses or income-tax refunds. Those are likely to get invested in the market, driving up share prices early in the year. Then, sometime around May 1, people notice that the market is somewhat overheated, and begin selling off those same positions.

Then there’s the fact that a correction in the stock market is more likely than not to happen at some point during the year. As Richard Leader of First Houston Capital has pointed out, there has been an average intrayear drop of 14.5 percent at some point during the trading year for the past 32 years. We know there are times when the market tends to rally, such as the January effect, which might make it more likely for those drops to occur in the summer months.

So “Sell in May” may not be such a half-baked idea. But the other half of the aphorism, “and then go away,” makes little sense. Any sophisticated investor knows that a drop in stock prices — especially one that is perceived as a simple correction and expected to be temporary — should be treated as a buying opportunity. An investor who sold in May would have missed the cratering of the S&P 500 last August — but one who had invested $1000 in the Vanguard Index 500 fund last August 8th would have $1242 by now. If that investor had waited until November 1st to make that investment, when the market’s traditionally stronger season was just beginning, he would have seen that $1,000 grow into just $1142. That’s an extra 10 percent just from bargain-shopping.  

There’s also the fact that some sectors tend to perform better in the summer, rather than worse. Sam Stovall of Standard & Poor’s separated out sector performance in those midyear months, when the overall S&P 500 was returning that tiny 0.4 percent. In the years from 1990 to 2011, Stovall found that the consumer staples sector was posting an average price gain of 5.0 percent in those summer months, and the healthcare sector was increasing by an average of 4.8 percent.

So savvy investors, far from going away after May, might want to work even harder to find the diamonds in the rough and the bargains that crop up every summer. It may not rhyme, but “Sell in May, and then take your investing materials to the beach” is better advice. 

For more investing advice, see also:

Crowd-Sourcing Stock Picks

Market-Neutral Investing

Watching the Fund Flows