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May 1, 2017

It’s May, Should You Stay or Go?

By Charles Rotblut, CFA, AAII

With May starting today, those of you who are sensitive to the market’s semiannual cycles may be reciting the chorus of The Clash’s 1982 hit, “Should I Stay or Should I Go?” A better question would be “Should I Stay or Should I Rotate?” Staying would mean not making any changes to your portfolio. Rotating would mean adjusting your equity allocation.

Before explaining the rotational strategy, some brief background on the semiannual cycles. While many of us will welcome the flowers and warmer weather May brings, Mr. Market tends to be more humdrum. Since 1945, the S&P 500 has realized an annual gain of 1.6% between May and October. Gains occurred during less than two out of every three of these six-month periods (64%). Once the chillier weather arrives in November, stocks heat up. The S&P 500’s annualized gain for the November through April period is 6.7%, with gains occurring 76% of the time based on data from CFRA investment strategist Sam Stovall. Hence the terms “best six months” and “worse six months.”

Keep in mind that the odds of increasing wealth while holding onto stocks during the worst six months are far better than what you’d find in Las Vegas or even by flipping a coin, for that matter. If the historical odds hold, you’ll even beat what you’d earn by staying in cash during the worst six months. Of course, the counter-argument will point to the 36% chance of losing money if you stay. Without risk, there cannot be gain. The key is to take smart risks. Here are three strategies.

The first strategy is to stay. Don’t do a thing. This is the traditional buy-and-hold strategy. The odds of making money increase with the time an investor maintains an allocation to stocks. Buying and holding also eliminates any timing errors you may incur by getting in and out of stocks. The timing error argument is big because research has shown investors tend to be really bad at identifying the best times to jump in and out. A constant allocation to stocks (adjusted for age and spending needs) is also the strategy that we, as an organization, espouse.

The second strategy is to rotate. This is Stovall’s strategy. Sam suggests allocating to the S&P 500’s consumer staples and health care sectors between May and October. Once November comes around, rotate into the S&P 500’s consumer discretionary, industrials, materials and tech sectors. These four sectors are held through April, when the rotation cycle restarts. In a report published earlier this week, Sam said that this rotation strategy realized an annualized gain of 13.6% versus 7.5% for the S&P 500 since 1990. The rotation strategy also incurred less volatility than maintaining a constant exposure to the S&P 500. A simpler version is to rotate between the S&P 500 (November to April) and health care/consumer staples (May to October). This strategy has realized a return of 11.0%. For those of you who are interested, S&P Dow Jones Indices now has a CFRA-Stovall Large Cap Seasonal Rotation Index based on the strategy. Equal-weighted ETFs for the aforementioned sectors are offered by Guggenheim Investments; you’ll have to do the rotation yourself, though.

If changing your portfolio every six months is too much work and/or you are concerned about the commission and tax costs (I haven’t seen the Guggenheim funds offered commission-free, though you could use commission-free traditional market-capitalization-weighted ETFs as a substitute), a middle of the road strategy would be to periodically rebalance your portfolio. As many of you already know, I check my portfolio’s allocation at the end of every April and the end of every October to see if any changes need to be made. Specifically, I look to see if any of the five funds I hold in my 403(b) plan, which is similar to a 401(k) plan, are over- or underweighted. I allow each fund to fluctuate within a 5% band, meaning that one or more funds must account for less than 15% or more than 25% of the total balance before I adjust the entire portfolio back to a 20% allocation for each fund. Most often there is nothing for me to do, as was the case when I looked at my allocation this past weekend. Plus, knowing that there is a plan in place should the allocations get out of whack gives me the confidence to let the money ride.

You could, of course, follow a mixed approach such as segmenting your portfolio among the buy-and-hold and Stovall’s rotational strategies. There’s nothing wrong with blending so long as you have a rational reason for doing so and the discipline for sticking to it. Just be sure to not put yourself in the position of having to ask “should I stay or should I go?”

The Week Ahead

First-quarter earnings season continues with 131 members of the S&P 500 scheduled to report. Included in this group are Dow Jones industrial average components Apple (AAPL), Merck & Co. (MRK) and Pfizer (PFE), all of which will report on Tuesday.

The Federal Open Market Committee will hold a two-day meeting, starting on Tuesday. The meeting statement will be released Wednesday at 2 p.m. ET. The CME Group’s FedWatch Tool shows traders pricing in a 96.8% chance of rates being kept unchanged. Odds for a quarter-point hike occurring at the June meeting currently stand at 68.0%.

Elsewhere on the economic calendar, March personal income and spending, the April PMI manufacturing index, the April ISM manufacturing index and March construction spending will be released on Monday. The April ADP Employment Report and the April ISM non-manufacturing index will be released on Wednesday. Thursday will feature March international trade, first-quarter productivity and March factory orders. April jobs data, including the change in nonfarm payrolls and the unemployment rate, will be released on Friday.

Four Federal Reserve officials will make public appearances on Friday: Vice Chairman Stanley Fischer, San Francisco president John Williams, St. Louis president James Bullard, Chicago president Charles Evans and Boston president Eric Rosengren.

About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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