Practical analysis for investment professionals
12 April 2016

Dumb Alpha: Sell in May and Go Away?

Dumb Alpha: The Sell-in-May Effect

Every April, I am asked by clients and fellow investment professionals alike if the old adage, “Sell in May and go away,” still holds true?

One of the key advantages of the ideas I present in the Dumb Alpha series is that they allow portfolio managers to rapidly improve their work-life balance. Since I am a naturally lazy person, I am constantly looking for ways to reduce my workload without my boss — or my clients — noticing.

The sell-in-May effect, also known as the Halloween indicator, is one of the most well-known calendar effects. It holds that investors can outperform a simple buy-and-hold strategy by selling stocks at the beginning of May and buying them back at the beginning of November. If this were true, I could dramatically improve my work-life balance by going on a six-month vacation in May, just to come back in November and work for six months until the following spring.

When I proposed this idea to my boss, he wasn’t very keen on it, arguing that, in largely efficient markets, this effect should not exist after transaction costs are taken into account. In other words, it should surely be arbitraged away by professional investors once widely known. I decided to dig in and look at the scientific evidence. After all, what is a weekend of extra research if one can expect to gain a half year off if proven right?

It is indeed correct that many calendar effects do not survive increased scrutiny. Examples like the turn-of-the-month effect or the day-and-night effect require quite a lot of trading in a portfolio. If trading costs are reasonably high, many of these effects become unprofitable. Similarly, some other well-known calendar effects, like the January effect, disappeared once they were described in literature and exploited by professional investors.

One of the first rigorous analyses of the sell-in-May effect was done by Sven Bouman and Ben Jacobsen, who looked at 37 international stock markets from January 1970 to August 1998. They found that the sell-in-May effect was present in 36 out of 37 countries and was statistically significant in 20 of them. The effect is not small, either. In the United States, Bouman and Jacobsen document a return in the November-to-April time frame that is 11 percentage points higher than in the May-to-October time frame; for the United Kingdom, the return difference is 24 percentage points — and can be traced back to the year 1694! So the sell-in-May effect has been around for a very long time, and, as it requires only two trades per year, it persists even after trading costs.

Efficient market advocates were quick to reply. Edwin Maberly and Raylene Pierce pointed out that the sell-in-May effect disappears in the US stock market once the months of October 1987 and August 1998 are excluded from the data. Could it be that the effect was caused by just two months of awful performance? If the returns were that lumpy, surely it wouldn’t be possible to exploit them, because most investors would have lost their jobs or given up long before the next event materialized.

In 2013, three researchers published what I consider the final verdict on the matter in the Financial Analysts Journal. Testing the sell-in-May effect with out-of-sample data from November 1998 through April 2012, they found that in the 14 years since the publication of Bouman and Jacobsen’s original analysis, the indicator did not disappear. In fact, on average, across the 37 markets studied, the out-performance in the winter months was still about 10 percentage points higher than in the summer months. They also found that the effect does not come in lumps. It exists in three out of four years and does not depend on specific industries, countries, or months.

It seems clear that the effect is both real and persistent. What causes it is totally unknown, although several hypotheses have been proposed, tested, and rejected. Here we have a Dumb Alpha generator that defies logic and explanation. But, as a mentor of mine used to say: “Truth is what works” — and, even though the underlying causes of the effect are unknown, it does seem like a true investment anomaly.

Now, I think I need to have a chat with my boss about my next vacation.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Joachim Klement, CFA

Joachim Klement, CFA, is Head of Investment Research at Fidante Capital and a trustee of the CFA Institute Research Foundation. Previously, he was CIO at Wellershoff & Partners Ltd., and before that, head of the UBS Wealth Management Strategic Research team and head of equity strategy for UBS Wealth Management. Klement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he holds a master’s degree in economics and finance.

11 thoughts on “Dumb Alpha: Sell in May and Go Away?”

  1. Lawrence Humphrey says:

    Although Nov-April is more profitable than May-Oct, the latter in general is not negative, right? i.e. there’s money to be made by staying invested during May-Oct.

    1. Joachim says:

      The interesting result is that the average profit in May to October is only slightly positive for the US. Investing in the winter months has underperformed a buy and hold strategy only by about a percentage point or less.
      Of course the situation is different once taxes are taken into account. Because selling an investment after six months triggers higher capital gains taxes the return of the Sell in May strategy is reduced. This can however be mitigated with the put/call techniques mentioned in another comment below.

  2. Neil says:

    Selling in May 2009 would have been Dumb with negative alpha!

    1. Joachim says:

      …but you gained more than twice as much in 2008 than what you lost in 2009. As I said the strategy doesn’t work every year but in average in three out of four years.

  3. stephen davenport says:

    The strategy introduces a simple idea but some taxable investors may find ways of combining put and call options around positions and accomplish similar out performance. After much research on the topic, the reasons could be liquidity related. When the volumes decline because of less market participants in these vacation periods, noise (possible negative events) can cause reactions which create negative results. The idea can be simple but extracting the Alpha is where it gets interesting! Great article…

  4. tony freeman says:

    Thanks for this comprehensive review of this extraordinarily persistent market imperfection. Why does it exist? In the City of London it is formulated as “Sell in May and go away, Buy back in St Leger Day,” referring to the horse race run at Doncaster in October. Historically the moneyed class would leave London to summer at their country estates, presumably putting aside financial matters until the autumn. The agricultural credit cycle might also have played a role: fully borrowed for planting in the spring, then on tenterhooks waiting for the harvest to come in and loans to be repaid. That would be true in other northern latitudes as well, including the US. And the rest of the world followed the activity in the two major capital markets of New York and London. But why has the effect persisted into the post industrial world? Does behavioral economics have something to teach us here?

  5. Brad Case, PhD, CFA, CAIA says:

    I make use of calendar anomalies in my accounts where transaction costs and tax implications aren’t a concern. Calendar anomalies are not yet explained and may not persist forever, but their historical track record is pretty impressive. Still, it doesn’t make sense to exit the equity market entirely at any time: I just move from one equity segment to another.
    May through September have historically (for the past 25 years) been good months for exchange-traded US equity REITs relative to other equity market segments; small-cap stocks have also been good in May, June and August; emerging markets have been good in July. (I look at medians as well as averages so I don’t get thrown off by a few outliers.) So in May, June and August I put about 2/3 in small-cap and 1/3 in REITs; in July I put 1/3 in emerging markets and 2/3 in REITs; and in September I shift everything to REITs. Nothing is guaranteed, but that has worked pretty well.
    March is the other month when my portfolio becomes 100% REITs.

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