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‘Sell in May and go away’ is the right strategy this year

by Wayne Cheveldayoff, 2006-04-27

Timing the market is always difficult to do and that is why some investment professionals advise against it.

But the stars are lining up for a substantial correction in the stock market in the coming six months, so the strategy of “sell in May and go away” – otherwise known as “buy when it snows and sell when it goes” – looks to be appropriate this year.

This strategy is a favourite of Don Vialoux, a chartered market technician, who thinks it is one of the stock market rules that works quite well. He operates the www.timingthemarket.ca website and comes up with strategies based on fundamental, technical and seasonal analysis of the Canadian and U.S. stock markets.

He recently advocated that investors take profits on their stocks and equity mutual funds because of the seasonal downturn in the market between May and September.

In the last 10 years, the Standard & Poor’s 500 index dropped an average 2.72 per cent during this period.

By contrast, the index gained an average 9.5 per cent in the past 10 years from October to April.

There are always exceptions, but this is not about hoping for exceptions. It’s about playing the odds based on the seasonal flows, which tend to push stock prices up in the October-April period and depress them in the May-September period each year.

Besides seasonal flows, a couple of other reasons to expect a market correction in the near future are the high energy prices and rising interest rates.

With political-terrorist tensions exacerbating the tight supply-demand situation for oil, it is unlikely that relief will come soon at the gas pump.

Inflation is picking up a bit and central bankers on both sides of the border are pushing up rates to prevent inflation from getting worse.

Interest rates are likely to continue to rise for the next six months and as they rise, it will be increasingly difficult for the stock market, particularly the U.S. stock market, to hold its current level. In Canada, it may depend more on energy and metals prices.

But even in the unlikely event that the Fed will immediately stop raising interest rates, don’t expect the stock market to keep pushing higher.

A U.S. research group, Ned Davis Research, recently examined the performance of the Dow Jones Industrial Average after the U.S. Federal Reserve ended a monetary tightening cycle, according to Mr. Vialoux.

From 1920 to 2006, during the six months following the last increase in the Fed Funds rate, the Dow declined in 12 of 16 such instances. The average decline was 6.17 per cent.

The main reason is that the Federal Reserve continues to increase the Fed Funds rate until it inflicts pain on the economy and the subsequent over-shoot in monetary tightening causes U.S. stock prices to come under pressure for at least the next six months.

While history is not always repeated, it nevertheless is a good teacher for investors.

Given what we know, if you own stocks directly or in equity mutual funds, does it make sense to hold on and hope for an exception to the rule?

I don’t think it does, unless you are holding very specialized funds, like energy or mining company funds or income trusts – all of which may avoid a downturn.

My vote is for taking some money off the table now – selling something like a quarter or a half of the equity exposure and leaving this money in cash or a money market mutual fund – and then re-entering the market when it appears to have bottomed in the fall.

Of course, there are also some other things to consider. If your holdings are in a non-registered account, there may be capital gains taxes triggered by the sale. And if they are in back-load mutual funds, there may be deferred sales charges on what you sell.

If you work with an advisor, you can expect the advisor to try to talk you out of selling, especially if you are in mutual funds. Advisors make trailer fees of between 0.5 and 1 per cent annually on your mutual fund holdings. Remember, it’s your money.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.

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©2006 Wayne Cheveldayoff