Don’t Be Quick to Sell (or Rotate) in May
Thursday, May 5, 2016

This week marks the start of what the Stock Trader’s Almanac refers to as the “worst six months” for the stock market. Relative to the “best six months,” stocks historically underperform during the period of May through October. Underperformance, however, should not be confused with losing money. Sam Stovall, the U.S. equity strategist at S&P Capital IQ, calculates the S&P 500’s annualized return for the worst six months period as being 1.4%. (Sam’s analysis starts on April 30, 1945.) Note the lack of a negative sign in front of the number: Stocks have, on average, realized gains during the worst six months.

Not every worst six-month period works out for investors. There have been some worth avoiding. Those of you who read Barron’s might have seen the data quoted from Bespoke Investment. The folks at Bespoke calculated an average return of -0.21% (yup, there’s a negative sign in front of the number) for May-October periods whenever the market was flattish during the first four months of a calendar year. This year happens to be one of those flattish years, with a 1.74% total return between January 1 and April 29. Before getting nervous, consider the sample size: there have only been 16 such occurrences since 1928. Plus, trends only last until they don’t.

There are tactical strategies an investor can use. Stovall compared four such strategies against a strategy of simply staying fully allocated to the S&P 500 index over the last approximate 25 years (December 31, 1990, through April 22, 2016, to be exact). Simply staying allocated to the S&P 500 without making any changes resulted in an annualized gain of 9.9%. Going to all cash between May and October reduced the annualized return to 8.9%, though it did have the lowest level of volatility of all five strategies. Moving into an investment tracking the broad Barclays Aggregate bond index (the iShares Core U.S. Aggregate Bond ETF (AGG) does this) boosted the annualized return to 11.3%. Sticking with stocks, but instead rotating into an investment tracking the S&P 500 Low Volatility index (the PowerShares S&P 500 Low Volatility Portfolio (SPLV) does this) boosted the annualized return to 11.9%. A statistically better strategy that Stovall has long talked about is rotating into the health care and consumer staples sectors (you can use the Health Care Select Sector SPDR (XLV) and the Consumer Staples Select Sector SPDR (XLP) to accomplish this). This strategy, according to Stovall, has delivered a 13.1% annualized return.

There are three big factors to take into consideration before following these strategies. The first two, obviously, are the risks of these strategies not working in the future and the tax and transaction costs of following them. The third factor is far more dangerous to your portfolio: the risk of you not rotating back into the S&P 500 when you should. Tactical strategies often sound great on paper. Implementing them, however, requires the discipline to follow the rules no matter what the market is doing and what your emotions would like you to do, something far easier said than done.

We humans have evolved with a deep-rooted aversion to loss. As such, we are at a psychological disadvantage when it comes to taking actions that are in the best long-term interests of our portfolio. When faced with tactical strategy signal to buy at a time when the market is experiencing turbulence, we humans feel a very strong temptation to bend (or completely break) the strategy’s rules. Doing so incurs the very real risk of reducing our long-term wealth. What commonly hurts investors is not staying in the market, but getting out. Mr. Market rarely gives signals when it’s time to get back in; rather, he pushes prices up while many investors are afraid to even stick their toes into the water. Unless you have proven to yourself the ability to follow a tactical strategy no matter what the market is doing (look at your past brokerage statements to see what you’ve actually done), simply adhering to a long-term, buy-and-hold strategy will give you greater wealth.

There are, of course, shades of gray. I personally use the beginning and ending of the worst six-month periods to look at my workplace retirement plan to see if my allocation has strayed too far off target. If any of the five funds held in my 403(b) account—the equivalent of a 401(k) plan—account for more than 25% or less than 15% of the total balance, I rebalance so that each fund has a 20% allocation. If all five funds are within the 15%-25% range, I do nothing. Then I don’t even so much as glance at the account for the next six months. Doing so allows me to adhere to my long-term plan without ever having to consider what the broader market is doing; I merely focus on the process.

Keep in mind that just because this works for me doesn’t mean it will work for everyone. We all have our own individual emotional triggers tempting us to make decisions that go against our long-term financial goals. It’s critical that you identify your triggers and create a system to combat them before deciding to follow any strategy that requires making periodic changes to your portfolio. When in doubt, consider that when tactical strategies are mixed with human emotions, the result is usually less long-term wealth.

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The Week Ahead

AAII President John Bajkowski will speak to our Washington D.C. Metro Chapter on Saturday, May 14, about how to find a winning stock.

Earnings season is starting to slow down as only 22 members of the S&P 500 are scheduled to report. The only Dow Jones industrial average component on the docket is Walt Disney Co. (DIS), which will report on Tuesday.

The week’s first economic reports will be March JOLTS (Job Openings and Labor Turnover Survey) on Tuesday and April import and export prices on Thursday. The week will close with the releases of April retail sales, the April Producer Price Index (PPI), March business inventories and the University of Michigan’s preliminary May consumer sentiment survey on Friday.

Five Federal Reserve officials will make public appearances: Chicago president Charles Evans and Minneapolis president Neel Kashkari on Monday; Cleveland president Loretta Mester and Kansas City president Esther George on Thursday; and San Francisco president John Williams on Friday.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $23 billion of 10-year notes on Wednesday and $15 billion of 30-year bonds on Thursday.

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AAII Sentiment Survey

Optimism among individual investors about the short-term direction of stock prices is at a three-month low according to the latest AAII Sentiment Survey. Pessimism is at a 10-week high, and neutral sentiment is higher as well.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 5.0 percentage points to 22.3%. Optimism was last lower on February 11, 2016 (19.2%). This is the 26th consecutive week and the 59th out of the past 61 weeks that bullish sentiment has been below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 3.3 percentage points to 47.3%. The rise keeps neutral sentiment above 40% for an eighth consecutive week. It also keeps neutral sentiment above its historical average of 31.0% for a 14th consecutive week and the 66th out of the past 70 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 1.7 percentage points to 30.3%. Pessimism was last higher on February 25, 2016 (31.4%). The increase puts bearish sentiment slightly above its historical average of 30.0%.

Ever since the S&P 500 index hit a 2016 high on April 20, optimism has declined by a cumulative 11.1 percentage points. The low level of bullish sentiment is a continuation of an ongoing trend. Fewer than one out of three survey respondents have described their short-term outlook for stocks as bullish during 23 out of the past 26 weeks.

Giving individual investors cause for concern is the slow pace of U.S. economic growth and uncertain global economic growth, terrorism and global unrest, lackluster corporate earnings and the prevailing level of valuations. Some AAII members, however, are encouraged by sustained domestic economic growth, expected corporate earnings growth and still-low energy prices.

This week’s special question asked AAII members how big of an impact news and data about China is having on their outlook for the U.S. stock market. Almost two-thirds of respondents (64%) said that China is having either no impact or just a small impact. Among the reasons given were a mistrust of the data about the Chinese economy, a sense that China’s economy does not directly affect the health of the U.S. economy and a perception that sentiment about China only has a short-term impact on U.S. stocks. About 27% of respondents said China has a big impact, particularly on revenues and earnings for U.S. corporations.

Here is a sampling of the responses:

  • “Somewhat, in particular for my commodity-based stocks.”
  • “A small impact. You can never trust China. China is a big market, but not an efficient one.”
  • “China’s buying power as it relates to its economy cannot be ignored.”
  • “Little long-term impact. China bulls and bears pay too much attention to the country.”
  • “Not too much. I think earnings of U.S. companies and overall economic growth will have a greater impact.”


This week’s Sentiment Survey results:

Bullish: 22.3%, down 5.0 points
Neutral: 47.3%, up 3.3 points
Bearish: 30.3%, up 1.7 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

AAII Asset Allocation Survey

Cash holdings among individual investors are at their lowest level since last summer, according to the April AAII Asset Allocation Survey. Conversely, allocations to equities and fixed income rose.

Stock and stock fund allocations rose 0.8 percentage points, to 64.8%. Equity allocations were last higher in December 2015 (65.3%). The increase kept stock and stock fund allocations above their historical average of 60% for the 37th consecutive month.

Bond and bond fund allocations edged up 0.1 percentage points, to 17.6%. Fixed-income allocations were last higher in May 2013 (18.1%). Last month’s modest increase kept bond and bond fund allocations above their historical average of 16.0% for the ninth consecutive month.

Cash allocations declined 0.9 percentage points, to 17.6%. This is the smallest exposure to cash since July 2015 (17.2%). April’s decline kept cash allocations below their historical average of 24% for the 53rd consecutive month.

There has been a gradual trend of rising fixed-income allocations occurring since last August. The cumulative increase is modest, however, with bond and fund allocations rising by just 2.1 percentage points over the past nine months. Equity allocations, meanwhile, continue to remain below the levels recorded during the first half of 2015. In the backdrop of these trends is ongoing frustration over the level of yields and a general lack of optimism for the stock market. The latter can be seen in our weekly Sentiment Survey; bullish sentiment has only exceeded 33% three times during the past 24 weeks.

Last month’s special question asked AAII members how they would change their allocation if yields were closer to their historical average. Nearly four out of 10 respondents (38%) said they would increase their fixed-income exposure, particularly by buying bond funds and exchange-traded funds (ETFs). Conversely, 27% said they would not change their allocations. About 13% said they would buy more stocks.

Here is sampling of the responses:

  • “Reduce stock allocation and add bonds.”
  • “I would increase my bond holdings to between 30% and 40%.”
  • “I wouldn’t. I follow a long-term investment strategy.”
  • “I would buy more dividend-paying stocks.”
  • “Less cash, more CDs.”
April AAII Asset Allocation Survey results:

  • Stocks Total: 64.8%, up 0.8 percentage points
  • Bonds Total: 17.6%, up 0.1 percentage points
  • Cash: 17.6%, down 0.9 percentage points

April AAII Asset Allocation Details:

  • Stocks: 30.7%, up 0.5 percentage points
  • Stock Funds: 34.1%, up 0.3 percentage points
  • Bonds: 3.9%, up 0.3 percentage points
  • Bond Funds: 13.6%, down 0.2 percentage points

    The numbers are rounded and may not add up to 100%.

Take the Asset Allocation Survey.


Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!