sell in May

Sell in May?

The conventional wisdom is that you should "Sell in May and walk away" from the stock market. The reasoning is that the Dow-Jones Industrial Average makes its biggest gains in the six months from November through April, whereas May through October is pretty much a wash.

yearly cycle of djia

The chart, courtesy of DogsoftheDow.com, illustrates that the market in summer can be choppy and October ends not much higher than May begins (the red rectangle). Take the summer off, it seems to say, and avoid all that anxiety.

trader paul's principle

But as Mark Twain supposedly said, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

Mark Twain

The notion of a half-year cycle has a specious appeal, but as I look at the chart the real time to be on the sidelines is roughly from mid-July through October. Particularly for the decade of the 90s, the DJIA has risen steadily through early July, but lost ground from then through October. If you're going to sell and walk away, the time to do it is Bastille Day (14 July), not May Day. In any case, the time to jump back in would be after Halloween. Maybe the French have it right after all: take vacation in July and August.

Taking a longer perspective, Michael Ashbaugh noted yesterday on MarketWatch.com that while the Dow Industrials took seven years to rise the 1000 points from 11,000 12,000, it has taken just six months to cover the 1000 points from 12,000 to 13,000.

DJIA 10-year chart
The last decade of the DJIA

The Dow's recent breakout to all-time highs is certainly impressive, and that is precisely why some in the chattering classes are talking "correction" or even "major correction." It's always good to be wary of irrational exhuberance, but it's also foolish to ignore the inertial principle that the market tends to keep going in the current direction until something happens to make it change.

presidential cycle

Furthermore, the presidential campaign is heating up, and the market tends to get a boost after the mid-point of a president's term (see right). The theory is that the "ins" always try to grease the economy leading up to the election to improve their reelection chances. Although there is uncertainty about which party will win in the next election, we are absolutely certain that the current administration will end, and that has to be viewed with relief, except, of course, for the 20-something percent who still think Bush is doing a good job.

Putting all this together, I think this is a time for cautious optimism. Looking through the charts of the stocks on my watch list, I find quite a few that seem to be ready for reversals of their short-term trends. Trader Paul intends to keep at it, at least until the Fourth of July.