Should Investors Sell in May and Go Away, or Ride the Bull Awhile Longer?

I'm sure you have heard the old saw that it's a smart idea to "sell in May and go away."

That concept is based on the notion that the May-to-November span provides a weak environment for investors. I have already heard the cry go up recently because the major indexes are already up a lot more than anyone expected, and this would seem to be a convenient time to take profits.

Yet like most old market adages, there's not much substance to the concept if you take a good look at history.

For one thing, I think it's wrong to lump bull markets and bear markets together when doing historical analysis of this nature, and have found some new Lowry's Research Corp. reports that back me up. Analysts at Lowry's Reports point out that bull and bear markets have their own rules and habits, and can simply not be assessed the same way.

Lowry's also points out that the May-to-October period is a long span with a great deal of variability within each of the months. For instance, it includes September, which is the statistically the worst performing month of the year with losses in 37 of the past 60 years, skewing results to the downside.

So Lowry's looks at the question a different way: How does the strategy hold up if the typically down month of September is excluded and only bull markets are considered?

After all, the market is clearly not currently in a bear phase, and it's a long time until September.

For the purposes of the Lowry's study, the performance of the Dow Jones Industrial Average was measured in all the bull markets since 1950, covering the period from the end of May to the end of August. The results suggest selling in May could be harmful to investment performances. In the 39 bull market years since 1950, the May to August period shows 30 gains but only nine losses. In addition, the gains far outpace the losses, averaging 4.7% versus declines of just 1.94%.

Lowry's evidence, therefore, suggests that in bull markets, being out of the market during the May-to-August period is much less profitable than being in. Last year that was the case for sure. The Standard & Poor's 500 Index was up 14% from May 1 to Aug. 31 and then tacked on another seven percentage points in September.

At present, of course, there are all kinds of indications that the broad market is very overbought and overdue for a correction of 3% to 5%. The CBOE put/call ratio is at its lowest level since August 2000, signaling that a lot more people are betting on a rising market than a falling market; the S&P 500 is at the top range of its 21-day trading envelope; all measures of new highs vs. new lows are at extremes; and the market has gone much longer than normal without a correction.

I have little doubt that a correction will come, probably sooner than later. But when it is in motion there will be a lot of question as to whether it signals the start of a return to the lows of February, or even last year. And it's important for me to point out that it's very unlikely that bears are going to be able to get much going.

Here's why.

Trending Towards the Upside
The chart to the left shows the trends of NYSE buying power (black line) vs. NYSE selling pressure (green line). These measure the forces of demand and supply. Last week, demand hit a new high for the cycle while supply hit a new low. This means that the smart, big money is not sneaking out the back door in anticipation of a decline. Far from it.

The big institutional money is still buying in anticipation of a transformation of the recent economic recovery into an economic expansion. These players - sovereign wealth funds, major corporate pension funds and the like - are not going to be put off by a dispute between the Securities and Exchange Commission (SEC) and Goldman Sachs Group Inc. (NYSE: GS) over the wording of some contracts, or even a dispute between Greece and its creditors. Those issues can roil markets for awhile but are unlikely to sink them.

Another indication of market health is the concept of "breadth," which also has rallied to a new high in recent weeks. This means that the rally is broad based among common stocks.

So the bottom line is that if and when a correction manifests itself, it's likely to just be a temporary phenomenon - a few days, a few weeks, maybe as much as two months - en route to higher prices down the road in the summer.

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