Sell in May and Go Away?

After market underperformance in the last few days, the adage has come back into vogue. But selling after a drop might not be the best idea.

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Why sell in May?

"Sell in May and go away" isn't just a clever rhyme. It's based on the historical performance of the DJIA, which typically grows less in the summer than in the rest of the year. It also applies somewhat less to the S&P 500, growth between May and October, compared to 7% in the other half of the year.

Of course, the performance doesn't always match historical averages each time - that would be too easy!

Last year there was also a significant drop in stocks at the start of the year, but then a substantial rise to new highs during the summer. And we shouldn't forget that the last two recessions before covid both started with market crashes in September.

Is it a good idea?

To figure out whether the pattern is likely to repeat this year, we'd have to understand why it happens. And there isn't much of a consensus on why stocks underperform during that period. Some cite weather, others point to tax filings in April, and others speculate on more esoteric psychological issues. Summer typically corresponds to marginally increased economic activity, so it's somewhat counterintuitive that stocks don't keep pace.

The thing is, this time around, the market has already dropped substantially since the start of the year, so selling in May doesn't offer the chance to "lock-in" gains. US Q1 GDP came in negative, as well as Q1 production. While high inflation means that holding cash (what happens after you 'sell') during the period doesn't seem like a good return on investment.

Selling with the trend

But that doesn't mean things necessarily will turn around. Selling in May this year is akin to trend following in a down trending market. The Fed is pulling capital out of the markets, which could keep a lid on stock market growth.

It’s worth noting that these are some extraordinary times, and probably not the best occasion to apply average performance from "normal" market behaviour.

And the chart...

The Dow Jones has lost significant ground since record highs but the 100-day average could offer support and lays a few points below the current price. Rejection has been seen twice at the said zone already as the Jan ’18 – Feb ’20 diagonal extends to the same territory. Below the 50-day average, however, the index could go either way despite expecting a short-term bounce.

Breaking the 100-SMA would lead bears to the Feb ’20 high of 29580. The 38.2% Fibonacci retracement of the 18153-37010 leg can be observed there too, and this forms a cluster.

If the CCI remains below -100 without forming divergence, the likelihood of a further breakdown will increase. On the other hand, divergence could lead to a decent move back up to the 100 and 50-day averages following a short-to-medium-term decline. Without one, the 50-day at 34802 is major resistance above 32500.

Source: Spreadex Trading Platform

Key takeaways

The performance of stocks is traditionally worse during the summer but that was not the case last summer. This year there has been a stock market sell-off since the start of 2022 already. Fundamentally, the Fed pressing the brakes and US Q1 GDP coming in negative add to the downside risks.