I don’t buy into superstitions.
I have no problem with Friday the 13th. You won’t find a rabbit’s foot hanging from my computer screen. My family even owned a black cat when I was a kid.
I just don’t see any supernatural forces at work there.
I think it goes back to my university training in physics.
As a physicist, I was trained to rigorously apply the scientific method. That means I let reality speak for itself.
You support a theory when reality confirms its predictions…but when those predictions prove to be wrong, you tear that theory down.
That’s not only the secret to success in experimental physics. It’s also a solid basis for investing.
But investors are only human. We’re hardwired to look for patterns, even when none exist.
Especially at this time of year, you might have fallen into the trap of trading superstitiously.
Here’s my advice about how to avoid that trap…
‘Sell in May and go away,’ is one of the stock market’s great persisting superstitions.
Some punters believe this saying is steeped in logic because it comes with a colourful old story. Here’s where it comes from.
Once upon a time, it’s said that the entire London financial district enjoyed a leisurely European summer. They were more focused on sporting events than their clients’ portfolios.
That meant there were fewer people buying and selling shares. That means higher levels of volatility. And with the buyers on holiday, it’s said that gravity would pull the stock market down over the warmer months.
This situation would last until the end of the northern summer in September.
To be precise, the second half of the saying is ‘come back on St Leger’s Day.’ The St Leger Stakes is the oldest of England’s five horseracing classics and is the last to be run.
With the suntanned stockbrokers back in their offices, stocks would resume a smoother upwards ride each year in September.
Or so the story goes.
Look, I can vouch for the fact that the European trading floors go quiet over summer. When I sold US equities in London, on some summer days you could almost hear a pin drop.
But the facts simply don’t support this idea that stocks always go down in May.
Don’t buy or sell blindly
‘Sell in May’ advocates usually point to the last few years as evidence that their theory is valid.
And to be fair, in May of each year from 2010 to 2013, Australia’s benchmark S&P/ASX 200 index fell by -7.86%, -2.38%, -7.29% and -5.10%.
A blindly superstitious May seller would feel vindicated.
But I don’t buy or sell blindly.
I’m either in the market or out of it, based on the underlying fundamentals.
And there’s a fundamental reason for each shaky May in the past four years.
May 2010, if you remember, brought the ‘flash crash’ and a deeply unpredictable Greek debt crisis.
2011 saw a relatively benign May, but the European debt situation was still stressing out global investors that month.
May 2012 saw a sharp sell-off of emerging markets as political upheaval threatened the Greek bailout. On top of that, the Spanish conglomerate Bankia sought its own rescue.
And last May, then US Federal Reserve chairman Ben Bernanke dropped his first hints that the Fed was thinking about slowing down its money printing presses.
But hey, let’s extend the retrospect by an extra year. If you’d chosen to sit out the six months from May 2009, you would have cost yourself almost 30% upside in the Australian, US and European stock markets. That was a huge result for large-cap stocks.
Here’s my point: when markets go up or down, there’s generally a fundamental reason that underpins the move.
Don’t bank on a coin flip
Stock markets are massively more sophisticated now than they were 100, 50 or even 20 years ago.
The days of lazy brokers nicking off to the polo and constraining the progress of an entire market are long gone.
So the colourful old story I told you earlier clearly has no basis as a reliable investment strategy.
There have been many, many years when “sell in May” hasn’t worked out.
And looking back over a 30-year period, it becomes a real flip of the coin. You can’t bank on that.
The statistics just don’t present a strong enough case for it.
I’m not trying to tell you that stocks always go up. I’m just saying there’s no room for emotion or superstition in the stock market.
When smarter investors catch wind of irrational behaviour, they exploit it ruthlessly. Don’t get sucked in.
Advice to profit
Here’s a strategy that outperforms ‘sell in May’, ‘buy before Halloween’ or any number of other bogus investment schemes.
Are you ready for it?
Here it is: buy stocks when they look undervalued relative to their potential. Then hold them long-term.
Yes, stocks have enjoyed a good rally over the past nine months. But you can still capture plenty of upside by investing in certain carefully selected companies.
Sometimes a stock’s story can take a while to play out. To benefit from the capital appreciation when catalysts ignite, you have to be in the market.
And market catalysts, be they macroeconomic or stock-specific, don’t wait for a calendar date.
Here’s the valuable point that punters who ‘sell in May’ ignore.
When you own dividend-paying stocks, you get paid to stay in the market and wait for those catalysts.
Dividends are an important component of total stock returns, especially here in Australia.
That’s even the case for some small-cap stocks.
Not every small-cap pays a dividend. But when they do, I look for companies that have a real prospect of raising that dividend, and also scream ‘buy me’ on a valuation basis.
I call those stocks ‘Turbo Caps’.
And there’s a few belters in that group among the exciting speculations on the Australian Small-Cap Investigator buy list.
If you want to generate real wealth through the stock market, you can’t get there by following kooky sayings and folk tales.
You get there by buying stocks for less than they’re worth…and holding them for the long term.
Cheers,
Tim Dohrmann+
Small-Cap Analyst, Australian Small-Cap Investigator
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