Why stocks hate summer

The most famous market adage of all is, "Sell in May and go away; stay away till St. Leger's Day." The 226-year-old St. Leger horse race, run in mid-September, marks the climax to the flat-racing season. The inference here is that there is no point trading in the summer because all the brokers and fund managers will be doing a bit of what Michael Neill in the FT calls "surf and turf"; namely, hanging out on the beach, or at sporting events such as Wimbledon and Ascot. That means that volumes will be low and markets more likely to fall. A large section of the City considers this complete nonsense. There's a "harder working culture to the City" than there used to be, insists Hilary Cook of Barclays Stockbrokers in the Daily Express. Selling in May and buying back in September is an "eccentric form of market timing", says David Kuo on Motleyfool.com. And a pointless one. It is, he says, "no more accurate than flipping a coin". But he's wrong.

You can time the market

ADVFN.com has worked out that following the old saying since 1984 would have returned 55% more than a simple buy-and-hold strategy. Anthony Hilton in the Evening Standard points out that, "on average, the market loses 1.8% of its value each summer, which, compounded over a couple of decades, makes for a tidy sum". Indeed, a loss of 1.8% a year for two decades compounds to an overall loss of 30%. And this isn't just true of the years after 1984: the Investors Chronicle reports that economist Ben Jacobsen has found that the sell in May' rule has worked for UK shares ever since 1964. The table below runs from 1966 and shows pretty clearly that January and April are good months to be invested, while June and September, showing average losses of -0.2% and -0.9%, simply aren't.

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Overall, in the last 40-odd years, you have been 50% more likely to suffer a down month between May and October than between November and April. Not only that, but the average gain in August, the best-performing summer month, wasn't materially better than March, the worst-performing of the winter months. That said, "Sell in May and go away" isn't perfect. Why? Because it suggests buying back in September, but October's usually rubbish too. This is the month the markets crashed in 1987, 1997, 1998, and most famously in 1929, and the Investors Chronicle study shows that October returns averaged just 0.6% over the last four decades. Perhaps it is best to buy back in November.

It's the same everywhere

A study by analysts Roy Young and Phil Kennedy at Mitsubishi Securities has shown that this same seasonality affects the Tokyo market. They tracked the average 30-day returns of the TOPIX index since 1970 and found that, from June to November, the market returns have been almost exclusively negative. However, from December through May, they have been almost entirely positive. And, odd as it seems that the aggressively professional Americans should suffer seasonal weaknesses too, they do."Here is a striking statistic," says Peter Siris in the New York Daily News. "Since 1950, 98% of the gain in the Dow has come between November and April." And in six of the last 17 years, the Dow's low of the year was in October. Arguably, it would have been seven times if September 11 hadn't rushed the Dow to a late September low in 2001. There were also big sell-offs, though not quite to new lows for the year, in October 1997 and 1999. No wonder American traders prefer to wait until Halloween (31 October) before they buy back into their markets.

It's even true in the bond market

There's less seasonality in the gilt market, but it's still there: the Investors Chronicle notes that "since 1969, gilt prices have fallen, on average, by 0.08% between30 April and 31 October. The rest of the year, they've actually risen by an average of 0.44%.

What's the cause?

According to the Investors Chronicle, there are two major factors behind the markets' ritual reactions to the seasons. The first is the fact that the winter tends to create economic risks. Since 1965, real GDP has fallen by an average of 4.9% in the first quarter of each year, having risen strongly in the previous quarter. This higher risk must be, and is, rewarded with higher returns. The second is purely psychological. In March and April, the lighter evenings cheer us up and we feel like taking risks, so we buy shares, pushing the market up in the process. Then, "from such high levels future returns are poor". Hence lacklustre summer returns. Equally, in September and October we start to feel "anxious and depressed", so we are loath to buy shares. The market falls, and then by the end of October shares are cheap and subsequent returns good.

But the first argument here - as the Investors Chronicle says - isn't supported by the facts. Australia does badly in the first quarter too, but Australian equities still perform better during their own winter (the UK's summer). Still, that doesn't mean that seasonality is all about our instinctive reactions to the amount of daylight we see. Instead, as Peter Siris points out, it is probably a bit more prosaic than that. June and July tend to be relaxing months for most, but come the end of the summer everyone starts worrying. There are elections to fuss about every few years and firms that aren't going to hit their forecasts start to issue warnings. Investors worry that "Christmas sales won't come and mutual funds do tax-loss selling. That's why early fall is even worse than summer."

The counter-point to the autumn blues is that September/October sell-offs create buying opportunities in November and December, while in New York, from January through March, markets are buoyed by "the influx of new money from corporate bonuses and pension plans, IRAs and companies spending their year-end surpluses buying their own stock to pay for employee stock options". Hence the good winter.

The attractions of AustraliEquity-market seasonality seems to be a factor of all equity markets. Whether it is worth trading, though, depends as much on your dealing costs and tax situation as anything else, but it certainly suggests the market may not be quite as efficient as the academics would have us believe.

But rather than selling in May and putting your funds into cash, perhaps the serious seasonal investor should consider moving into southern hemisphere stocks for the summer. Since 1973, Australian stocks have underperformed UK shares by 4.5% from November to April, but outperformed by more than 3% between May and October. It seems that, south of the equator, the pattern is the same as ours: "they do well during their winters and badly during their summers".