If you watch as much business television as I do, you’ve likely heard the old adage “sell in May and go away,” especially lately. The saying, which originated in the United States, succinctly summarizes years of research that suggests that stocks underperform during the summer months.
There are many theories about why this happens. Many investors are on vacation during the summer months, which takes away liquidity from the market. This also takes away potential buyers for stocks. Additionally, many investors contribute to their accounts during winter months, especially during RRSP season. This could explain the relative demand for stocks during the winter.
But the strategy seems to work. From 1956 to 2011, investors who bought the TSX Composite Index (TSX: ^OSPTX) between November and April and then switched to bonds between May and October would have enjoyed a 13.5% annual return. That compares to a 9.2% return if the same investor had used a buy and hold strategy, and just 7.7% if the investor stuck to investing in bonds.
In the United States, the outperformance of the plan is even more pronounced. The S&P 500 returned more than 8% annually between November and April, and saw returns fall to just 2.9% during the summer months.
But still, the plan isn’t foolproof. Investors only have to look briefly to find a year that bucked the trend. In 2013, the TSX was up more than 9% during the summer months (excluding dividends), even including a sharp selloff in July. The market was only up 10.6% for the entire year. Investors who implemented the strategy last year would have been sorry.
And there lies the weakness in selling in May and going away. History has shown it works the majority of the time, but do you really want to take the chance of missing out on a summer like last year? In fact, hindsight shows that there were some pretty good buying opportunities during that stretch.
So what’s an investor to do?
I recommend a slightly different strategy. Sell your winners in May if you were going to anyway. I like this strategy. It even rhymes.
If you’re sitting on a nice gain on a stock and are thinking of selling, this could be a nice time to lock in profits. But don’t just sit on the cash once the position is sold. Investors looking for short-term profits could look at some of the sectors that traditionally outperform during the summer, like telecoms, utilities, and consumer staples. Or they could take the opportunity to redeploy the money elsewhere.
Last year, from May to October, Dollarama (TSX: DOL) returned more than 30% to its shareholders, thanks to terrific results, strong same-store sales numbers, and bullish sentiment for its industry. Dollarama has outperformed during the summer months every year it’s been a publicly traded company.
Should investors buy Dollarama because of its potential to outperform over the summer? Maybe. Should investors buy Dollarama because it’s well positioned, is expanding rapidly, and is a terrific operator? That argument makes a great deal more sense.
It’s the same thing with Telus (TSX: T)(NYSE: TU), which has done well for four out of the last five summers, with the notable exception being 2013. Investors should consider investing in Telus now because of its growing TV business, its attractive 3.7% growing dividend, and its solid wireless brand across the country. The company’s proposed $350 million takeover of smaller rival Mobilicity doesn’t hurt either.
It’s simply a silly idea for investors to sell in May and go away. It would cost a significant amount, both in commissions and opportunity costs. Recent results have done their best to disprove the theory. And besides, most investors have a pretty poor record of trying to time the market.
Instead, investors should take the opportunity to look at selling some of their winners, and then repositioning that capital into different investments. Finding stocks with a history of outperformance during the summer is a nice bonus, but your outlook should be long term, not just over the summer.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith has no position in any stock mentioned in this article.