There is an old investment saying: “Sell it in May and go away”. It describes a strategy that recommends investors to close their positions in May and reopen them in October. Let’s delve into the details and see this is relevant to the current state of the market.
A bit of history
It is believed that the practice of selling shares in May originated in England, somewhere between 1694 and 1776. The full version of the said looks as follows: “Sell everything in May and leave the market, come back on St. Leger’s day”. This reference to the horse races of St. Leger, the last leg of the British Triple Crown, a purebred horse racing competition that takes place every year in mid-September.
In the warm season, the rich lords really had a habit to move from London to the country, to their summer estates. Since they did not have the opportunity to keep an eye on their assets while away from the city, they sold everything and waited for the late fall. It is believed that this behavior had a significant impact on the market and became a kind of recurring effect.
The so-called Halloween effect is also closely related to the described phenomenon. This is the theory that the market shows better results between October 31 and May 1, or in the winter months. It is still believed that large investors will become more active during cold times, opening positions on the stock market. Additional investments further stimulate liquidity in the market.
So, the Halloween effect, or Halloween strategy, encourages investors to buy assets between the end of October and the beginning of May, and just like the saying goes, sell everything at the end of May and return to the market by All Saints’ Day. But here’s the question: can this method really bring profits, or is it just an echo of more propitious times? As with any other popular theory, the Halloween effect has both supporters and skeptics. It is probably reasonable to listen to the arguments of both sides.
British stock market historian and trader David Schwartz believes that although investors consider the “sell it in May” approach worthy of attention, it has not been relevant for many years.
Schwartz analyzed the century dynamics of the stock market in Britain and concluded that following the strategy was a reasonable idea only in 1980-1990 when the “bullish” movement in the market was simply unprecedented.
In contrast, between 1920 and 1970, the market in Great Britain grew only in 65% of cases between November and April, and between May and October, it grew in 58% of cases studied. In the context of these data, the practice of investors who tried to make money simply by applying a seasonal strategy did not look particularly successful, since the division into “favorable” and “unfavorable” seasons appeared quite insignificant.
Sure, in the last two decades of the XX century, stocks were growing from November to April for 20 years and added about 12.5% per year. In the “unfavorable” season, the average growth in the best years was 1.5%. On the other hand, with the advent of the XXI century came the years when the market grew in “bad” halves. That is why Schwarz calls the Halloween effect in the last two decades of the XX century “a brief historical anomaly.”
Those in favor
On another hand, you can find a stack of studies the results of which indicate in favor of the Halloween effect. For example, the work with the funny title “The Halloween Indicator is More a Treat than a Trick”, written by economists from three American universities.
Their research showed that from May 2007 to October 2015, the Halloween effect was still present in 34 of the 35 countries where the research was conducted. And while statistical significance has been identified in only six countries, the authors are confident that the effect will continue in the near future and offer their interpretation of this phenomenon.
Based on the theories of market efficiency and rational expectations, the authors speculate that many investors are well aware of the Halloween effect and expect the market to go down in May and rise again in early November. So as the warm season approaches, portfolios are being liquidated to return to the market in the fall. Thus, the Halloween effect may be fuelled by nothing more than the very beliefs of investors themselves.
And yet, how viable is the strategy?
For those involved in portfolio investment, consultants do recommend rebalancing at least once a year. However, there are usually no specific periods for this.
As for the Halloween effect itself, as with any other trend, it should be treated with some caution. Investor behavior, which formed the trend, can always redistribute cash flows at a time that is not convenient for you. If you do decide to try this strategy, it’s wise to combine it with technical and fundamental analysis.