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An Annual Worldwide Optimism Cycle (Sell in May)?

Posted in Animal Spirits, Calendar Effects

Does the conventional wisdom to “sell in May,” with the average stock return during November-April far exceeding that for May-October, work for the world equity market? If so, why? In the November 2005 version of his paper entitled “The Optimism Cycle: Sell in May”, flagged by a reader, Ronald Doeswijk examines the hypothesis that this seasonal pattern derives from an annual optimism cycle. Using monthly return data for markets, sectors and Initial Public Offerings (IPO) over the period 1970 through 2003 (34 years), he concludes that:

  • The return for the MSCI World index in U.S. dollars during November-April exceeds that during May-October by an average 7.6% per year, and November-April beats May-October about two out of three calendar years (see chart below).
    • For the 17-year subperiods 1970-1986 and 1987-2003, the return for the MSCI World index in U.S. dollars during November-April exceeds that during May-October by an average 7.5% and 7.7%, respectively.
    • Shifting the six-month periods one month forward or backward weakens the difference between winter and summer. When December (October) is the starting month for winter, the difference between winter and summer is 5.4% (6.2%).
  • A hedged global equity capitalization-weighted sector rotation strategy that is long (short) cyclical (defensive) stocks during November-April and short (long) cyclical (defensive) stocks during May-October generates an annualized return of 7% over the entire sample period, with positive returns in 26 of 34 years. Results for subperiods, bull and bear markets and the U.S. alone are similar.
  • Global corporate earnings growth revisions follow a similar seasonal pattern, with analysts initially presenting a this-year-growth-will-be-higher-scenario that deteriorates during the second half of the year. The earnings revision cycle lags stock market returns by about a month.
  • IPOs introduced during November-April have initial returns 4.3% higher than those for IPOs introduced during May-October.

The following chart, taken from the paper, shows average total return for the MSCI World Index in U.S. dollars by month during 1970-2003. The best (worst) months of the year are December, April and January (May, August and September).

In summary, evidence from multiple tests supports belief in an annual optimism cycle as a principal cause of the worldwide outperformance of stocks during November-April compared to May-October.

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