Why Investors "Sell in May and Go Away"

The time-value-of-money concept forms the basic foundation for all investments.

And like anything having to do with people, there are rhythms to the stock market that are a function of time-- whether it is the time of the trading day or a particular time of year.

One of these seasonal rhythms is so strong it has given birth to its own adage. Every investor knows it.

It's the admonition to "Sell in May and go away," and it's a proven strategy that results in gains for investors.

According to Sy Harding, author of the book "The Bear: How to Prosper in the Coming BearMarket:" "Over the long term, the market makes most of its gains each year in the winter, and when there is a serious correction, it most often takes place in the summer. We've known about that pattern for decades. The pattern has been confirmed by independent academic studies."

The Logic Behind "Sell in May and Go Away"

There are a myriad of reasons for this, most having to dowith the cash flow aspects of the business calendar.

Harding suspects "that the pattern is caused by large extra chunks of money that flow into the market beginning in the autumn with the annual capital gains distributions of mutual funds in November, Christmas and year-end profitsharing bonuses, employers' year-end contributions to employee's 401k and IRA plans, and ending in April with income tax refunds."

Other factors not cited by Harding include the business, tax and financial calendar for both companies and individual investors.

In practice, many companies typically place orders beginning in January as the New Year takes hold. That is particularly true for technology stocks, which traditionally have their strongest period from late fall through the spring.

According to John Wagonner, financial columnist for USA Today, tech stocks "fare well in cold weather." Waggoner says, "The old rule of thumb was to buy tech stocks in November around when the American Electronics Assoc. holds its annual meeting and sell them in May, when West Coast investment banker Hambrecht & Quits had its conference."

Sam Stovall, a tech strategist for Standard & Poor's Capital IQ, also reports that tech stocks average 6.99% gains in the fourth quarter versus the 4.9% gains for the overall Standard & Poor's 500 Index.

This seasonality is often a function of how tech companies tend to introduce new consumer goods before the holiday shopping season and business products before the beginning of the New Year. It is no surprise then that Apple will introduce the iPhone 5 in October of this year.

Of course, individuals also play into the seasonality of the stock market.

At the start of the year, individual resolutionsto save more often include fully funding an individual retirement account or college savings plan. Moreover, individuals also need to capitalize their retirement accounts by April 15, which directs flows into the stock market in the spring.

Conversely, summer vacations take a large swath of investors away from the stock market.

And when leaving for vacation, individual investors sometimes prudently close out positions, particularly open buy orders. This combination of events leads the stock market lower for the summer vacation months.

Historically,June, August and September are the three worst performing months for the Dow Jones Industrial Average, according to the StockTrader's Almanac.

Sell in May and Go Away is a Worldwide Phenomenon

According to Harding, it is not just financial markets in the United States.

The "Sell in May and go away" phenomenon is worldwide. Harding notes that, "My research shows that global markets tend to move in tandem, not only in the annual seasonal pattern, but also into and out of bear markets, and even into and out of short-term pullbacks and corrections."

In the Stock Trader's Almanac, the "Best Six Months Switching Strategy" features "Sell in May and go away" as its foundation.

Under this investing regimen, funds flow into the Dow Jones Industrial Average from November 1 to April 30.From there, for thenext six months, investors transfer their capital over to fixed income financial vehicles. According to the Stock Trader's Almanac, this"...has produced reliable returns with reduced risk since 1950."

In fact, according to an independent academic study by Ben Jacobsen of the Rotterdam School of Management in 2002, the "Sell in May and go away" strategy produced consistent results.

The study concluded that, "We found this inherited wisdom of 'Sell in May' to be true of 36 of 37 markets. A trading strategy based on this would be highly profitable in many countries."

This certainly appears to be the case for 2012.

Recently, Jeffrey Hirsch, the editor of the Stock Trader's Almanac, warned that, "We're on the brink of a sell signal."

Given the old adage, we shouldn't be surprised.

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