Stocks: Brighter Times Ahead?

November begins what is usually the strongest six-month stretch of performance for the Standard & Poor's 500, says S&P's Sam Stovall

By Sam Stovall From Standard & Poor's Equity Research

Just How Bad Was This October?

Sell in May and Then Walk Away

S&P 500 Sector Average Changes and Compound Annual Growth Rates

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What can you say about a month in which the Standard & Poor's 500-stock index fell 18.2%, recording the ninth-worst performance of any month since 1929 (as of Oct. 30), the third-worst results for an October in 79 years, and—if 2008's 35% year-to-date loss had been a full-year result—would have been the third worst behind 1931's slump of 47.1% and 1937's drop of 38.6%? What else is there to say but good riddance?

Silver Linings

Inside every cloud, however, there is a silver lining. In other words, when life gives you lemons, make whiskey sours. There is at least one positive regarding the market's recent performance: The old Wall Street adage "Sell in May, and then walk away" was never more prophetic than this year. Since World War II, the S&P 500 gained an average 6.8% in the November-through-April period, but only an average 1.1% from May through October. What's more, this seasonal favoritism has worked whether you start from 1929, 1945, 1970, or 1990. From Apr. 30 through Oct. 30 of this year, the S&P 500 slumped 31.1%, recording the worst May-October decline since 1928.

Had an investor sold his stake in the S&P 500 index on Apr. 30 of this year, he would have avoided the 31% slump in U.S. equity prices through Oct. 30, which was punctuated by an 18% decline suffered in October alone. In addition, had an investor embraced the "Sell in May" discipline of sector rotation by selling out of the S&P 500 and buying into either the S&P 500 Consumer Staples or Health-Care Sector indexes, their annual rate of relative outperformance since 1990 would have widened to more than 400 basis points, as the declines for these two sectors were about half of that suffered by the overall market.

On Nov. 3, however, we entered into what is usually the strongest six-month stretch of price performance for the S&P 500 index. Since World War II, the S&P 500 gained 6.8% in the November through April period, and the "500's" average return outpaced that for the May through October period 72% of the time. Again, this seasonal favoritism has been consistent whether you start with 1929, 1945, 1970, or 1990.

Reasons For Disparity

Why? We believe share-price weakness from May through October may be the result of seasonal considerations, as investors focus more on their tans than their portfolios. In addition, September has proved to be the worst month for U.S. equity prices, possibly in response to analysts typically reducing their full-year earnings estimates as third-quarter results are about to be released.

The November-April stretch, however, not only has benefited from this regularly low starting point, but also has been aided by large cash infusions early in the new year from pension funds, 401(k)s, bonuses, IRA contributions, and tax-refund reinvestments. November is also around the time of year that analysts begin looking ahead by five quarters, rather than just focusing on the final one.

Sector Standouts

Since the defensive Consumer Staples and Health-Care sectors have traditionally outperformed the S&P 500 during the challenging May to October time frame, it should come as no surprise that the cyclical sectors have tended to do better during the more favorable six-month period for equities. Indeed, six of the 10 sectors within the S&P 500 beat the broader benchmark during the November through April period. When also considering frequency of beating the S&P 500, the three best performing sectors from November through April since 1990 were Financials, Industrials, and Materials.