How to Earn a Year's Worth of Stock Gains in Just 6 Months
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You've probably heard that Wall Street saying, "sell in May and go away."
Well, what that adage leaves out is the fact that you should come back in November.
That's because the six-month period starting today has historically delivered 85% of the annual gains for stocks. Since 1945, the S&P 500 has returned 6.9% on average from the start of November through April, according to Sam Stovall, U.S. equity strategist for S&P Capital IQ. That compares with annual gains of just 1.4% from May through October.
This November-April surge, sometimes called the Halloween effect, is even more pronounced when investing in small-company stocks. Since 1926, shares of volatile but fast-growing small companies delivered 10 times more gains from November through April than they did from May through October, according to an analysis by The Leuthold Group.
This seasonal quirk isn't just limited to the U.S. This phenomenon has been identified and verified in 36 different markets around the world.
Why the disparity?
The old explanation was that with summer vacations, there's just less trading that takes place in the middle of the year. But as the calendar shifts to November, Wall Street's workforce is back.
Probably the more realistic explanation is that at the end of the year, bonuses start to kick in. Then at the start of the following year, hope springs eternal just as investors are likely to contribute to their IRAs and boost contributions to their 401(k)s.
All of that new money being put to work supports stock prices.
So how do you take advantage of this?
Most investors don't jump into and out of the market for large swaths of time. And as this story in April explained, that's smart: Even if returns are low on stocks in the summer, so are the gains on the other investments (such as cash and bonds) you would hold instead.
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That said, there are some seasonal moves you can make that may add to your returns over time.
* Rotate your stocks. Instead of "sell in May and go away" followed by a November return, think about being defensive in the summer and aggressive afterwards.
Stovall found that in the summer months, the best performing areas of the market were defensive in nature. For instance, the leading sectors that outperformed the market from May through October are consumer staples and healthcare. Neither group requires a particularly robust economy to thrive, since people need toothpaste and medicine in good times and bad.
Come November, though, investors start to get adventurous. Among the best sectors in this stretch are economically sensitive areas such as consumer discretionary, industrials, technology, and financials.
* Don't rebalance now—wait until the middle of next year. Around once a year, investors are advised to rebalance—that is, to reset their mix of stocks, bonds, and other assets back to their original plans. If you don't, your portfolio will grow increasingly stock heavy over time, since equities typically outpace bonds over the long run.
This can be a difficult step to take, though, because rebalancing requires you to sell winners to buy losers.
But if you rebalance in May (not this month or next), you will be selling stocks when they are about to embark on their weakest period, when they exhibit bond-like returns.
And both psychologically and financially, this will make it more palatable to do the right thing.
Rebalance near the year end, and you're more likely to feel the pain of seeing the stock market rise just after you've sold.