John Lynch Chief Investment Strategist, LPL Financial
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“Sell in May and go away” is probably the most widely cited stock market cliché in history. Every year a barrage of Wall Street commentaries, media stories, and investor questions flood in about the popular stock market adage. This week, we tackle this commonly cited seasonal pattern, while focusing on some reasons it may not apply this year.
THE WORST SIX MONTHS OF THE YEAR
“Sell in May and go away” is based on the seasonal stock market pattern in which the six months from May through October are historically weak for stocks, with many believing that it’s better to simply avoid the market altogether and move to cash during the summer months
As discussed on the LPL Research blog last week, the S&P 500 Index gained 1.5% on average during these six months (since 1950*), compared with 7.1% during the November to April period. In fact, out of all six-month combinations, there has been no worse return, on average, than the May through October period.
BEWARE OF MIDTERM YEARS
Midterm years can also be quite troublesome for equities. In fact, out of the four-year presidential cycle, the S&P 500 tends to have an average peak-to-trough pullback of 16.9% during a midterm year, which is the most out of the four-year cycle. The good news is that a year after the calendar year lows are completed, the S&P 500 has been up 32.0% on average.
Looking at the May through October period during a midterm year shows a similar pattern. During midterm years, the S&P 500 has gained only 0.1% on average during these six months, the worst out of the four-year presidential cycle. It also sees an average peak-to-trough pullback of 14.7%, the largest pullback during these six months out of the four years [Figure 1]. So the calendar is a potential concern over the coming months, but as we discuss below, we see reasons to believe the pattern may not hold this year.
Going all the way back to the origin of the Dow Jones Industrial Average in 1896, we see similar potential seasonal weakness over the coming months. Breaking things down by quarters, the second and third quarters of midterm election years are historically two of the weakest [Figure 2]. Once again, the good news is that stocks tend to rebound strongly after these weak patches.
Why do midterm years tend to see more stock market volatility? One theory is that the party that wins the presidency tends to lose seats in the House and Senate, which greatly increases uncertainty. The uncertainty is alleviated after the election and, during a bull market, stocks may resume their rally.
WHY THE PATTERN MAY NOT HOLD THIS YEAR
So, will the S&P 500 fall over the next six months? We don’t think so—and here’s why. Lately, the “sell in May” adage hasn’t rung true. In fact, the S&P 500 has closed higher in May during each of the past five years and has risen over the entire six-month period during five of the past six years, with an average gain of 4.8%. In fact, the only time equity prices were lower was in 2015, when the S&P 500 lost only 0.3% during these six months.