The old adage in stock markets is that investors should ‘sell in May, go away and don’t come back until St Leger’s Day’ but is there really any credence to the idea? 
The phrase has been appropriated by believers in stock market seasonality but in truth its origins appear to have little to do with market returns, according to Jason Hollands, managing director at Tilney Group.
“It is believed to date from a time when the City resembled a private gentlemen’s club and stockbrokers hung up their bowler hats for the summer to enjoy ‘The Season’, a period of sporting and social events including Royal Ascot, Wimbledon, the Henley Royal Regatta, Cowes Week and ending with the St Leger flat race in Doncaster in mid-September,” Hollands (pictured) said.
However, over time this has grown into the idea that the summer months are a dangerous period, with a high incidence of market sell-offs.
Believers of this theory point to the idea that with more people on holiday, trading volumes are thinner and therefore smaller moves have more of an impact on the market.
As such, they suggest selling out of the stock market for the summer and to buy back in again in the autumn.
Hollands has studied the theory using the FTSE All Share over the time period since the ‘Big Bang’ reforms of 1986 and said there is little to back up the theory.
“This massive shake-up saw the deregulation and opening up of the City including the introduction of electronic trading and so we think the post-Big Bang period is the right one to assess whether there is something in the theory or if it is a myth that can be discarded,” he said.
Source: Tilney Group
As the above chart shows, share prices as measured by the capital return on the FTSE All Share Index have been positive and negative 16 times each during the period between May to mid-September over the last 32 years.
This suggests there is no firm conclusions for the theory either way, Hollands said, but noted that once dividend payments are factored in and returns are measured on a total return basis, UK stock market returns have been positive 66 per cent of the time during the summer.
“This compares to markets generating positive returns 78 per cent of the time across the full calendar years in question. There have however been very significant variations in returns during the summer,” he explained.
“Firm believers in the ‘sell in May’ theory can point to seven brutal summer sell-offs since Big Bang when the capital returns on UK shares posted double-digit declines: 1992, 1998, 2001, 2002, 2008, 2011 and more recently in 2015.
“However, selective memory might mean they ignore the six soaring summers of 1987, 1989, 1995, 2003, 2005 and 2009 when the markets posted sizzling hot gains.”
As such, while market returns in the summer months can be unpredictable, systematically exiting the market during this period does not convincingly stack up as a strategy in the modern age, Hollands said.
“Pursuing such an approach could also clock up transaction costs and capital gains tax liabilities, which are not factored into our research,” he added.
One reason investors should stay the course over the summer is because it is generally when most of the dividend-paying companies make their final payments.
As such, investors contemplating exiting the market for the summer should note the ‘record date’ at which they must still hold their shares to be entitled to receive any final dividends for the year.
“Where dividends are reinvested during the summer months, including those periods where share prices have fallen, this has a powerful compounding effect on overall returns,” the managing director said.
Overall, he said trying to accurately predict short-term market movements, is a “mug’s game” as big market moves are often triggered by surprise news or events that can take place at any time of the year.
“They are not something that can be conveniently scheduled into a calendar alongside the Chelsea Flower Show or Wimbledon,” Tilney’s Hollands said.
“It is therefore better for investors to stay focused on their long-term strategy rather than get blown off course by speculating about what markets might throw up over the short-term.”
Average CAPE ratio of markets
Source: Tilney Group
And when thinking about where to invest, he said one key metric to look at is the cyclically-adjusted price-to-earnings (CAPE) ratio.
Global emerging markets, which have a CAPE of 13.82 versus its long-term average of 15.79 is one area that also looks attractive, he argued, along with the UK.
“While it is impossible to know for sure what the summer of 2018 will bring for investors, UK shares look decent value compared to both other developed markets and their own history [on this metric],” Hollands said.
As the below chart shows, over the last three years the UK’s FTSE All Share has been the worst performing of the major market indices, in sterling terms, returning just 22.55 per cent.
Performance of indices over 3yrs
Source: FE Analytics
“The discount on UK shares is undoubtedly down to political uncertainties weighing on sentiment and a lot of anxiety seems priced in,” said the Tilney managing director.
But there are positives for investors to draw, including a more positive outlook for oil prices, as the FTSE All Share index has a 12.8 per cent weighting in oil & gas companies.
There are also signs that the discount on UK valuations might be a factor in throwing up event-driven opportunities in the UK market such as mergers & acquisitions and activist investors targeting stocks as companies become takeover targets for overseas competitors.
“There are plenty of reasons to why we might see surprises on the upside over the coming months as we have seen this week with the proposed deal between Asda and Sainsbury,” Hollands added.