Sell in May? No Way!—Searching for Alpha for April 2013

With April here, and following a rather good first quarter for equities (see below) it’s that time of the year to once again debunk one of the great myths of investing. 

Each May, throngs of investors sell their stocks, only to buy them again in early November. The so-called “sell in May and go away” crowd believe that the seasonal tendency of equities to swoon in the summer months and into early fall is so persistent that it makes sense to only own stocks for the six months beginning in November.   

Recent results have made more believers. Consider last year’s drawdown in stocks brought about by fears of a European economic collapse. A good chunk of the pain from 2008 could have been avoided from that year’s meltdown as well.

Is there anything to this strategy? A number of academic papers have shown that there is a tendency for stocks to underperform in the middle of the year. One study showed that the effect holds true in 36 of 37 developed and emerging markets studied. Even so, here are three reasons to think twice before dumping stocks next month and re-buying after Halloween:

Reason 1: Data Mining  
In reality, market returns are so volatile that taking away or adding just a few days from each summer period typically eliminates any seasonal effect. And since most May-October periods end with smaller but still meaningful profits than the other six months of the year, investors are missing out on gains they would have achieved from a buy-and-hold strategy. It isn’t as though the equity risk premium suddenly disappears when the weather gets warm.