Why the old adage to sell in May is flawed

By Justin Urquhart Stewart, Co-founder.
25 April 2017.

“Events, dear boy, events” was Prime Minister Harold Macmillan’s infamous reply when asked what the most difficult thing about his job was. In other words, stuff happens and politicians have to deal with it.

That of course goes for the rest of us too including investors – hence the wonderfully irreverent resonance of the phrase. Indeed, financial markets are having more than their share of events thrown at them, with a lot of them are caused by the politicians!

Election fever is a case in point. In the UK, the recent announcement of a snap election reminds us that just when the market is facing one way (the consensus way), then it is usually the time to look the other way and manage the risks of exactly the opposite. Indeed, the immediate aftermath of May’s unexpected announcement saw a higher Pound and a falling FTSE 100 – it seemed so unlikely, but then so did the UK referendum and US Presidential election results last year. But how many investment managers have learnt from that?

One of our own preoccupations is anticipating unexpected events of this kind and managing the risks accordingly – a scenario driven approach that takes a range of outcomes into account. So a soft Brexit would likely see Sterling rally against other currencies, and damage our large allocation to foreign currencies. A hard Brexit would leave Sterling at recent lows, but would help those same foreign currency holdings. So how do we position portfolios to cope given both outcomes could be driven by political events? In addition to our tactical management of Sterling versus foreign currencies, we recently also took the decision to buy a one-year investment in the form of a call option that could curtail our pain in the event of a surprise rally in the Pound.

Looking beyond the UK over the Channel to France, political events are also driving markets in Europe. These have risen in recent days on the back of the political pollsters’ confidence about the result of the French Presidency – due to be decided on 7 May.  But, while markets have already ticked up anticipating an Emmanuel Macron victory over Marine Le Pen, we believe there’s lots of good news in Europe. European companies, for example, are having one of their best periods for earnings since the financial crisis – growing revenues rather than cutting costs – and recent Purchasing Manager Index numbers just published were also very strong. This could lead all mean fresh fund flows into Europe.

Of course, some world-weary, politically-jaded investors may be thinking that with May approaching, it is a good time to lock in gains and go on holiday. Holidays, of course, are the kind of “event, dear boy, event” that we can all get behind (for my own part, I’m taking five weeks off over summer to go on an archaeological dig!). But while I can’t knock a holiday, I can say that the “sell in May” adage is as flawed as it is tired.

Let’s take two example investors to highlight how: Steady Eddie and Holiday Helen. Back in January 1987, they both invested in a fund that effectively copied the FTSE All Share Index. Steady Eddie simply left his money invested over the 30 years, while Helen sold her investments on 30 April each year and reinvested the proceeds every September (about the middle of the month). But how did each of them do?

Well, both strategies produced good returns, but (between the two) Steady Eddie did better, especially if you look at how his investments compounded over the time. He did that bit better as the index yielded positive returns 60% of the time over all those 30 summers (i.e. in 18 of the 30 years). So, Steady Eddie saw an annualised return of 9.2% versus an 8.1% for Holiday Helen. Taking the compounding into account made Steady Eddie even better off: he benefitted from a 1,290% gain; Holiday Helen meanwhile ‘only’ saw a 927% increase.

Now, some would be quite right in pointing out that selling in May would have proved to be a good strategy in 2001 and 2002. Here, Steady Eddie could have avoided – as indeed Holiday Helen did – losses of 18.9% and 21.7% respectively. Helen could have headed off for the London summer social season – from Ascot, Wimbledon and Henley to Lord’s – and have benefited from her investment strategy!

But focusing on the odd year or two can also firmly debunk the myth. Last year is one such example. The fallout from the Vote to Leave saw investors buy UK shares as they were able to enjoy the relatively higher value of the overseas earnings streams from the underlying companies given how far the Pound had tumbled. Meanwhile, selling in May in 2009, when markets were recovering really quite sharply from the financial crisis, would have seen you miss a 20.9% increase over the summertime.

For me, a strategy that fails 60% of the time has to be seen to be fundamentally flawed.  I firmly believe that it is time in the markets that’s your friend – and treat “events, dear boy, events” with the same philosophical attitude as our former Premier.

 

 

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