Do you avoid the stock market's worst six months or hold on?

By Mark Hulbert

Why 'buy and hold' does better than 'sell in May and go away' and most other market-timing bets

Some stock market pros believe they have a way to do better than the six-months-on, six-months-off seasonal trading pattern known as the "Halloween Indicator." Their strategy is not to "sell in May and go away" - avoiding the market's typically worst six months. It's to sell now, in April, and get ahead of the pack.

This "jump start" approach is just one of several different ways in which advisers try to tweak the Halloween Indicator. Here's a review of the different approaches of which I am aware, and their performance records.

1. The "original" strategy

The original Halloween Indicator strategy waits until April 30 to get out of stocks and re-enter the market on Oct. 31. Since its creation, the Dow Jones Industrial Average DJIA has returned 5.3% on average between Oct. 31 and April 30 (the so-called "winter" months). In the "summer" months between April 30 to Oct. 31, the Dow's average gain was 1.8%. (The difference between these two returns is significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine.)

Despite this statistical significance, this original strategy doesn't necessarily make more money than buying and holding a U.S. market index fund. That's because the stock market's below-average summer return may still be better than the interest you could earn by going to cash over that time. Since 1934, the earliest date for which I could obtain data for 90-day U.S. Treasury bills, the Dow's average summer return was 1.9%, slightly better than the 1.7% comparable return of T-bills.

This advantage of buying and holding throughout the year was particularly evident in recent decades when interest rates were below average. My auditing firm has data for this original strategy back to May 1990. Since then it has produced a 9.5% annualized return, versus 10.7% for buying and holding a broad stock market index fund (as represented by the Wilshire 5000 Total Return Index XX:W5000FLT).

2. The 'jump start' strategy

Several newsletters over the years have recommended different versions of "jump start" strategies. Nowadays I know of only one: The Stock Trader's Almanac, edited by Jeffrey Hirsch. He writes that "beginning on the first day of April, we prepare to exit... as soon as the market falters," and do just the reverse in the fall: "Starting on the first trading day of October, we look to catch the market's first hint of an up-trend." (Hirsch relies on a trend-following indicator known as MACD, which stands for "moving average convergence divergence." Market weakness at the beginning of April was enough for him to shift to cash in this strategy - almost a month before the original strategy will do so.)

My performance auditing firm has data for this "jump start" strategy back to mid-2002. Since then, a portfolio that switched between the Wilshire 5000 index and T-bills on Hirsch's signals would have produced an 8.1% annualized return. That's identical to the 8.1% return produced by the "original" strategy, and 1.8 annualized percentage points lower than buying and holding.

3. The 'sector rotation' strategy

This strategy is a variant on the original strategy, but instead of shifting to cash during the summer months it instead shifts to more conservative sectors of the stock market. It shifts back to more aggressive sectors in the winter months. This particular approach has been championed by Sam Stovall, chief investment strategist at CFRA Research. He introduced a version of the strategy in his 2009 book, "The Seven Rules of Wall Street," and in July 2018 an exchange-traded fund was created to follow it: The Pacer CFRA-Stovall Equal Weight Seasonal Rotation ETF SZNE

The ETF has significantly lagged a broad-market index fund since its creation. From the beginning of August 2018 through this March, according to FactSet data, the ETF produced an annualized return of 9.5% annualized, 3.5 annualized percentage points below the 13.0% annualized return of the Wilshire 5000 Total Return Index. The strategy performed much better in back testing.

4. The 'sitting out midterm summers' strategy

This variant of the Halloween Indicator goes to cash for just one summer of every four. It is based on research that found that the Halloween Indicator exists only because of the summer prior to mid-term U.S. elections and the subsequent winter. In the other three years of the U.S. presidential cycle there is no statistically significant difference between the returns of the summer and winter months.

In fact, an approach that goes to cash in the summer months prior to midterms, but otherwise stays fully invested, has done significantly better than the original strategy. Since 1990 it has produced an 11.5% annualized return, 2.3 annualized percentage points better than the original strategy and 1.1 annualized percentage points better than buying and holding.

Yet because 2024 is not a midterm election year, the investment implication of this strategy for the next couple of years will be no different than buying and holding a broad market index fund.

Three of the four variants on the original Halloween Indicator strategy have a mixed record, adding value over some periods but not all. The one that more consistently comes out ahead, as you can see from the table above, is the "sitting out midterm summers" strategy. Keep this in mind in April 2026, two years from now, before the summer prior to the next midterm elections.

In the meantime, buying and holding a broad market index fund may be the best way of profiting from summer seasonal weakness in the stock market.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: High-flying stocks mean everything to Wall Street - but not Main Street

Also read: The U.S. stock market has outperformed Europe's for years. 2024 could be different.

-Mark Hulbert

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04-08-24 1639ET

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