Why “Selling in May and Going Away” Could Be a Huge Mistake This Year

As I write, stocks are selling off for the sixth day in a row. That’s resulted in a 2.4% decline for the S&P 500 Index in May. And we’re only seven trading days into the month!

Remember, this performance comes on the heels of one of the strongest starts to a year in decades for stocks. From January through April, the S&P 500 leapt 9.2%.

Against such a backdrop, it’s easy to understand why many investors are now tempted to follow the market wisdom to “sell in May and go away.”

But don’t do it! Here are five reasons why…

Lies, Damn Lies and Statistics

When you see a chart like this one from U.S. Global Investors, I’ll admit it’s hard not to give into the temptation to bail on stocks right now. It shows the monthly performance for the S&P 500 since 1998, as well as the frequency of positive returns.

Clearly, stocks post positive returns more frequently during fall and winter months than summer months.

Recent events only reinforce this trend, too. You’ll recall, stocks got tripped up last May and fell 17%, before regaining their footing in October and rallying into the year’s end.

So why shouldn’t we give into statistics and sell in May?

Reason #1: We’re being lied to. Maybe that’s a bit harsh. It’s more accurate to say we’re being misled.

You see, most studies don’t go back far enough in time. If you noticed, the U.S. Investors analysis only went back to 1988. And that leads to inaccurate and incomplete results.

Reason #2: Most studies don’t take into account trading commissions or, more significantly, taxes. Remember, selling in May means incurring short-term capital gains taxes.

So what happens if we go back further in time?

Based on Ibbotson data from 1926 forward, Motley Fool editor, Alex Demortier, found that simply buying and holding onto stocks is our best bet.

And what happens if we factor in our biggest expense, taxes?

Northern Trust’s (Nasdaq: NTRS) research, which goes back to 1945, proved a sell in May strategy couldn’t hold a candle to simply buying and holding.

So don’t be duped. Selling in May and going away is not all it’s cracked up to be. Especially this year…

Don’t Get Out of Stocks When Americans Get Out to Vote

I know it’s dangerous to say, “It’s going to be different this time.” But it is going to be different this May through October for the simple fact that we’re in a presidential election year.

Reason #3: During election years, studies show the summer swoon doesn’t materialize. Instead, the markets tend to rally the most in the summer months of June, July and August.

Government conspiracy theorists can appreciate this tendency, too. It would be terrible for either political party’s nominee to have markets crater leading up to an election. So politicians are bound to pull out all the stops to prop up the markets in 2012.

Beyond this presidential election year phenomenon, there are other reasons to stay invested despite the recent selloff.

Reason #4: Like Wall Street’s extreme bearishness…

According to Bank of America’s (NYSE: BAC) U.S. equity strategy team, strategists are now “extremely bearish” and underweighting equities. The latest reading of the firm’s proprietary Sell Side Indicator is more than one percentage point below the extreme bearishness level of 55.6%.

In my book, that qualifies as a contrarian reason to be bullish on stocks. Especially since the last time strategists were this bearish, stocks surged.

Reason #5: Finally, there’s Main Street’s absolute mistrust of stocks…

Despite Chief Executive of 2100 Xenon Group, Jay Feuerstein’s, insistence that “there are many investors willing to put money to work on dips,” the data doesn’t back him up.

According to the Investment Company Institute, retail investors have yanked more than $260 billion out of stock mutual funds since the end of 2008. In contrast, they’ve plowed $800 billion into bond funds, which yield next to nothing.

Given all the bearishness and mistrust, now strikes me as the perfect time to remember one of Warren Buffett’s classic rules: “Be fearful when others are greedy, and be greedy when others are fearful.”

Bottom line: When you factor in trading commissions, taxes, presidential elections, analyst sentiment and investor behavior, selling in May and going away promises to be a losing strategy in 2012. No matter how poorly stocks have performed over the last week.

Ahead of the tape,

– Louis BaseneseSource: Wall Street Daily

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