The Tell: Seasonality screams sell, but here’s why retail investors shouldn’t listen

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Investors prone to heeding seasonal patterns are probably scurrying for the exits right now. With the Dow Jones Industrial Average DJIA, -0.22%  deep in the red and volatility VIX, +5.70%  spiking, “sell in May” and “avoid the midterm election cycle” sound like timely advice.

But don’t be so easily shaken, says Urban Carmel, former president of UBS Securities in Asia and now the man behind the Fat Pitch blog.

“Is the next half year a land mine… ?” he asked. “The short answer is no.”

First, Carmel tackled the second year of a president’s term, which, as you can see by the chart below, is generally considered to be the weakest of the four-year cycle for the stock market. October is where things turn around significantly:

“While it’s generally true that stocks are weaker in midterm years than in other years, stocks have still risen an average of 4.5% during this period (since 1928),” he wrote. “That may be less than other years, but it is still a decent gain.”

Those numbers don’t tell the whole story, though. In 2006, 2010 and 2014, the S&P 500 index SPX, -0.40%  rose at least 11%, and furthermore, if you go back to 1982, the average second-year gain is a strong 9%. In fact, midterm years have outperformed the celebrated third year more than half the time over that period.

The same point basically rings true for summer seasonality. Yes, as this chart illustrates: The next six months historically underperform with an average return of about 2% vs 7% in the following half year:

And, of course, some of the biggest crashes in recent memory have occurred in the summer, including in 2008 and both 2001 and 2002. There’s also the fact that big bull-market rallies are much less frequent during the dog days.

But, again, there’s more to it than just those trends.

“Net, if you sell in May, you should expect to buy back higher in November,” Carmel wrote. “For most investors, that’s all that matters.”

In other words, yes, selling in May will keep you out of the historically weaker stretch, but to what end? The market STILL tends to rally over the time frame. So it brings us back to one truism we can absolutely count on: Retail investors, with an eye on the long haul, shouldn’t time the market.

For those investors bent on trying to pick their moments, however, Carmel says there’s a general strategy to keep in mind as we move into the summer.

“A swoon in May-June often sets up a bounce higher in July,” he said. “Likewise, a swoon in August-September usually sets up a bounce into October and the end of the year,” and that also corresponds with the rally in the presidential cycle seen in the first chart above — the seasonal low point typically comes in September before a strong push into the fourth quarter and third year.

So far, the market is sticking to the bearish script, with blue chips down on Thursday almost 300 points in their fifth straight losing session, while the Nasdaq COMP, -0.32%  dipped below 7,000 for the first time in three weeks.