Why It Might Not Pay to Sell in May

Equity markets have rallied a long way since the March 2020 trough. After falling 34% in just 24 trading days – the fastest ever bear market decline – the S&P 500 has climbed 88% since the 2020 lows and is now trading at record highs above 4,200, notes Mark Haefele, Chief Investment Officer, UBS Global Wealth Management.

We are now entering a time of year when stocks have historically found it more challenging to advance. With many equity indexes making new highs, some measures of sentiment looking extended, and ongoing concerns about the spread of new COVID-19 variants, investors may be tempted to follow the old adage: Sell in May and go away.

The sell-in-May hypothesis proposes that equities tend to underperform in the six-month period between May and October. History offers some support for the idea. In Europe, for example, over the past 15 years returns have been negative in June 80% of the time. This has contributed to a sell-in-May strategy outperforming a stay-invested strategy during those years (sell stocks at the start of May and invest in cash to re-enter the market in late autumn).

But while we expect periodic bouts of elevated volatility to continue in the coming months, we think staying invested with a diversified approach is preferable to selling in May, says Haefele for a number of reasons:

1. The sell-in-May strategy doesn’t work consistently across markets.
While the strategy has worked for Europe, in the US a stay-invested strategy has tended to outperform, particularly in recent years. Market composition, with the US market more tilted toward growth stocks, partly explains the outperformance. The tech sector’s weight in the S&P 500 has increased to 27% compared with a weighting of just 8% for MSCI Europe. Trying to time the US market for seasonal reasons would have missed out on the outperformance of growth stocks in the bull market since the 2008-09 financial crisis.

Equity returns for the May to October period vary considerably across different markets, but also with considerable volatility between years for any given market. For example, China equities rallied by more than 20% between May and October in 2017 and 2020, and Eurozone equities rose by more than 10% in 2013.

2. This year may be different.
There is considerable year-to-year variation in returns over the summer months. In the current environment, it may be premature to expect a near-term peak in equities. The effect of fiscal stimulus and the post-COVID-19 bounceback in consumer and business demand is leading to extraordinary levels of growth, particularly in the US, that are likely to persist for a number of months yet. In turn, this supportive macro backdrop is feeding through into a stronger-than-expected recovery in corporate earnings – US 1Q profit growth will exceed 45%. In our view the rally in stocks has further to run.

Experience from last year already shows that selling in May would have missed out on an important part of the recovery from the pandemic lows. Roughly one month after the March trough, global equities (MSCI AC World Index) had already recovered 25%. Global equities gained a further 12% from May to October 2020.

3. Timing markets is difficult and can be costly.
Last year saw the sharpest US bear market in history, but also the fastest market recovery. This is a good example of how trying to time the markets can involve significant opportunity costs. For investors selling in May, buying back later can be psychologically difficult, particularly if markets have rallied in the meantime. This can delay the decision to reinvest even further, potentially compounding the effect.

Moreover, in the current environment, holding cash for too long is expensive. With nominal interest rates lower than inflation, real rates are negative, so cash will be a significant drag on portfolios. It’s also worth remembering that selling and reinvesting involves transaction costs and may incur capital gains taxes. Remaining invested means returns are compounded on a larger pretax portfolio.

As we approach May, we think investors should prepare for more volatility. But rather than “sell in May and go away,” we advise investors to stay invested and take the following three actions: First, revisit long-term financial plans; second, diversify across key themes, regions, and asset classes, including alternatives – a strategy including both reflation and growth plays can reduce the risk that investors are caught on the wrong side of a market rotation; third, consider utilizing volatility to invest, diversify, and protect.

Bottom line: We are entering a time of year when stocks have historically found it more challenging to advance. With many equity indexes making new highs, investors may be tempted to follow the old adage: Sell in May and go away. But the sell-in-May strategy doesn’t work consistently across markets and we see reasons why this year may be different. Timing markets is also notoriously tricky and can be costly. So we think staying invested with a diversified approach is preferable.