Traders' views - Spread betting

Will the 'Sell in May and Go Away' rule work this year?

By , 03 May 2012

"If past history was all there was to the game, the richest people would be librarians," says Warren Buffett. So can we rely on the stock market's favourite history lesson this year?

It’s that time of year when the well-worn trading saying 'Sell in May' is wheeled out again.

Most readers will have heard of the stock market saying ‘sell in May and go away’, which is based on the historical tendency (link is to a pdf from IG Markets) for stocks to generate most of their positive returns during the six-month period from 1 November through 30 April.

According to the Stock Traders Almanac, if you went long the market on November 1, 1972, and spent 37 years selling all of your holdings on April 30, then re-buying on November 1 and doing it all over again, you would have earned an average annual return of 7.4%. If you would have done the reverse — buy in May and sell in November — your return would be a measly 0.4% over the same 37 years. Whilst 7.4% may not sound very exciting remember you were out of the market for 6 months so much less risk and you could place your money in other assets during that period.

Of course nothing is ever assured in financial markets and I like to say “seasonality is a guide not a guarantee” but there is plenty of evidence backing up the sell-in-May mantra. Unlike many trading systems that have ambiguous rules, it’s not that difficult to back test a seasonality system with a fixed entry and exit date rule.

Selling in May 2010 and 2011 both worked very well and kept you out of trouble. 2009 did not work well but if you recall that was when the US Federal Reserve started quantitative easing which helped to pump up markets over the summer so it was hardly a typical year.

Of course as investors we don’t get paid for the past so the question is what next?

How to invest in 2012?

2012 is a US presidential election year so the seasonality pattern could be affected by any shock announcements, but so far markets have been so strong in 2012 and I don’t see why the Fed needs to do anything in the next few months.  I think that the overall US indices will stay in a trading range over the next few months before the next run up.

So far this year markets have been very strong with the S&P up 11% and the NASDAQ100 up 20% thanks to the big move in Apple and other technology shares.

What I do expect is nearer to the election to see some pressure on oil prices and unleaded gasoline, as if Obama wants to get re-elected he needs to get gas prices down in the run up to the election. WTI Crude is currently at $106 and taking into account the current demand supply for oil I am amazed its anywhere over $100.

The main factor holding oil over $100 is a risk premium coming from Iran and other possible conflicts in the coming months but taking that out I see a WTI of nearer $80 by November than $110. I have not made a trade yet based on lower oil but am looking to do something.

Bet on defensives and avoid metals and mining

Of course the whole stock market does not stop, so there are still plenty of opportunities in individual shares and sectors both long and short. It’s no surprise that the sectors that tend to do better over the May to October period are the more defensive sectors, which can also be accessed via a spread bet or contract for difference (CFD) on exchange-traded funds (ETFs – about which you can read more here on BullBearings), such as consumer staples (NYSE:XLP on Google finance), healthcare (NYSE:XLV on Google finance) and utilities (NYSE:XLU on Google finance). Telecom shares such as Dow veteran AT&T (T) should also hold up well in the next few months and they pay a large dividend, currently yielding 5.3%

I would stay away from energy (NYSE:XLE on Google finance) and metals and mining (NYSE:XME on Google finance) for at least the next few months. Gold and silver are both looking weaker and I expect to see lower prices into September and then we may have a buying opportunity.

 

Warning: Remember, particularly if you are new to trading in the stock market and in forex, that the prices of shares and other investments can fall fast and you may not get back the money you originally invested. The material here is for general information only and is not intended to be relied upon for individual investment decisions. Take independent advice before making such decisions. Also, the BullBearings free stock exchange simulation portfolios are a good way to practice trading techniques.

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