It’s Almost May: Should You Stay With Stocks or Go?

With May starting in just a few days, 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?”