The media loves to hype up anomalies in the market and there are two many of us are hearing now. We believe investing based on these anomalies is a flawed approach. Let’s look at both the “Sell in May and Go Away” trading strategy and the Presidential Election Cycle anomaly. We would argue that market valuation is a better approach to investing than following these headline grabbing strategies. A great example to illustrate our point is to look at the 2008-2009 time period.
Yes, there has been a higher chance of making money using the “Sell in May and Go Away” approach, but the study sample size is very small – less than 100. We all know that the stock market suffered significant losses in 2008 and started recovering nicely in 2009. Using the “Sell in May and Go Away” strategy during this time would not have been effective. In 2008, one would have looked smart if they had sold at the beginning of May 2008 as the stock market (as measured by the S&P 500 Index) lost -15% through the end of September. However, using this approach over the next 12 months would have proved unsuccessful as the stock market fell almost -24% from October 2008 through the end of April 2009. From May-September of 2009, the stock market was up +22.3%.
Another example of a flawed strategy is the Presidential Election Cycle Theory, which says to buy in the last year of a presidency and avoid the first year of a presidency. This strategy is also predicated on a small sample size. Part of the thought is that in the last year of a presidency, the government is more fiscally and monetarily accommodative to help with the election. That becomes less so the first year of a presidency, knowing there are three years left in the term. Under this philosophy, an investor would have been fully invested in 2008 and out of the market in 2009. Not a good approach as the stock market was down -37% in 2008 and up +26% in 2009.
What does this mean for your portfolio?
If the US stock market declines over the next few months, we believe it will happen because of the overvaluation of the market as valuations of the S&P 500 CAPE (cyclically adjusted price/earnings) ratio is at its third highest point in history (higher only in 1929 and 2000) – not because of the “Sell in May and Go Away” strategy. We continue to underweight US stocks, overweight energy and emerging markets stocks and overweight uncorrelated investments (hard assets, managed futures and long/short fund) based on valuations, not studies using small sample sizes.