Written by Sam Kovacs.
Introduction: Does Selling in May make sense?
"Sell in May and go away."
This Wall Street adage, with roots going back to 18th century England, has somehow endured the test of time. I've always been fascinated by these seasonal shifts and trends in the market.
The original phrase was "Sell in May and go away and come back on St. Leger's day." St. Leger's day usually lands somewhere in the middle of September. The idea was that British investors should sell their shares to enjoy a summer of stress-free leisure before coming back to their investments in September.
While I was born in the UK, this notion seems so foreign to me, as in the past 4 years, I've taken a 10-day break for my wedding, two short 4 day breaks, and that is it. How is one expected to enjoy the summer if the fun and thrill of stock markets is stripped from him? Maybe others don't think like I do, and this would show in the data.
Indeed, in this year's copy of the Stock Trader's Almanac, shows that the data for the NYSE and NASDAQ continues to support two seasonal lulls in trading volumes: July & August, and the second half of December.
The author of the Almanac explains:
The individual trader, if they are looking to sell a stock, is generally met with disinterest from The Street. It becomes difficult to sell a stock at a good price. That is also why many summer rallies tend to be short lived and are quickly followed by a pullback or correction.
He continues:
A prolonged surge in volume during the typically quiet summer months, especially when accompanied by gains, can be an encouraging sign that the bull market will continue. However, should traders lose their conviction and participate in the annual summer exodus from The Street, a market pullback or correction could quickly unfold.
While I do understand and appreciate the idea, when we look at the numbers for the S&P 500's (SP500) average monthly returns, sorted by month, for the past 75 years, my takeaways are quite different.
Historically, June and July have been very strong months. If you look at the past 75 years, these months have average positive returns. Over nearly all the time periods highlighted, July is usually one of the best months after only November.
On the other hand, September is consistently the worst month for the stock market, with August being consistently unreliable if we look at average returns.
The S&P 500's returns in September have been all over the map.
The median monthly return since 1950 has been 0.4%, but the average return has been -0.5%, which tells us that the bad years have been worse than the good years. That is true, with 8 years with returns worse than -7%, and only 2 years with returns above 7%.
Over the 74 years, 38 have been positive, 36 negative.
Now do not get me wrong, this is considerably worse than data for November, the best month, historically. November has been positive 58 times, had a median return of 2.66%, average of 2.36%, 9 years with returns superior to 7%, and only 4 years with returns worse than negative 7%.
So, yes, September can get dicey, but why would you really want to sell in May, knowing that the historically second-best month of July is just around the corner?
The answer is: You don't.
So, Sam, when do I want to sell?
What "selling in May" suggests, is moving entirely out of your stocks in May, to come back at the beginning of November, just because "May to October is the worst 6 months of the year."
This, to me, is a fundamentally bad strategy, which goes against the long-held adage that you should seek "time in the market vs. timing the market."
This is an idea which, I believe, is fundamental to successful investing. As Peter Lynch famously said: "more money has been lost in preparing for bear markets than in bear markets themselves."
What he meant by this is that you leave a lot of money on the table when you raise cash to avoid the next crash.
Over time, around 2 out of 3 days in the stock market have been positive. Being invested in stocks, is like having the house's edge at the casino. In fact, if the casino gave itself such a huge edge, nobody would bet there.
In stock market terms, it means that nobody should hold cash over being in stocks. Yet people do.
The quote "time in the market vs. timing the market" has been hijacked by "buy and hold" investors who never sell their shares. Those folks harass me, saying that selling stocks is a loser's game every time I suggest selling one of their favorites.
There is a reason that most of the research on stocks suggests buys or holds, and not sells. People don't like you when they tell them to sell.
Nonetheless, I think investors should sell when shares are overvalued. This isn't timing the market, it's rotating out of high-quality names which are historically overvalued to high-quality names which are undervalued, realizing value, tilting the value factor in our factor once again, and increasing our dividend income in the process.
A Few Case Studies
As dividend investors, our DFT charts serve as a good starting point for determining over and undervaluation. If you're new to our DFT Charts, check out this blog post.
These charts provide a clear way to see, relative to the past 10 years, if a stock is trading at a relatively low dividend yield (and thus might be overvalued) or a relatively high dividend yield (and thus might be undervalued).
The table below shows the portfolio's trades in Exxon (XOM), a dividend aristocrat.
We started buying XOM in January 2021 (at inception of the portfolio), at a cost of $54. We added to the position in March and August 2021 at $57 and $58.
We then sold our position in 4 increments:
- 12% of the position at $80 in March 2022.
- 22% of the position at $99 in June 2022.
- 17% of the position at $110 in November 2022
- 51% of the position at $110 in January 2023
You'll note that just as we slowly accumulated our position, we slowly exited it to enjoy more of the upside.
We exited XOM at an average cost of $105. We missed the highs of $120. Oh well, we don't mind, close enough to the top and bottom is good enough to do well.
Today XOM is at $113, so since we sold the last increments in November and January 2022 it has made no progress.
On the other hand, you could have identified and bought stocks with the proceeds which would have done very well.
Another, more recent example is IBM (IBM), which we wrote about selling in the linked article here.
In January, as IBM surpassed $170, I explained:
IBM's yield is back at levels which have historically been overvalued in the past decade.
As such taking 1/8th of the position off the market is smart and reasonable at this point in time.
Technically IBM has breached the range it has traded at in 2018-2023. The question is now can it reclaim $175 and go above?
If it can, there are strong chances the stock will at least make a run at challenging the all time high of $205.
The 3.87% yield already doesn't make sense to me given the 0.5-1% dividend growth we've been getting.
However, revenues are growing at 4-5%, which if translated into dividend growth of the same magnitude, would justify a 4% yield.
This is a big if.
So we're starting to offload IBM, slowly but surely.
1/8th at $170.
Then more at $185, $200, and if we breach $205, we'll have to reassess based on the market situation at that point in time.
IBM topped at $199, and we missed selling that 3rd increment. Nonetheless, we've captured gains at a time when the stock has been heavily overvalued, and now have the opportunity to do so again if the stock resumes its rally. If it doesn't, then we still own IBM, a fine company.
Of course, this doesn't always work in such a clean manner, and sometimes stocks power on higher.
This was the case of Booz Allen Hamilton (BAH), which we suggested selling in increments at $110, 120, and $130. We ended up exiting our position at an average cost of around $125.
We exited the last of our position on August 11th 2023, and the stock has powered on to above $150 since then.
Some people will view this as proof that our model doesn't work. Once again, this doesn't consider that the proceeds from BAH were reinvested into other stocks.
Just two weeks after recommending selling BAH, I suggested buying Dicks Sporting Goods (DKS) at around $113, saying:
I think DKS should be a $200 stock by 2025, which makes it an easy buy at these levels.
DKS shot up to $225 this year, before correcting and is now at $180. Now I'm willing to give up a 25% gain if it means moving to a 60%+ gain AND getting paid more dividends in the process.
2 Stocks To Sell In May
This was a long-winded way to suggest that while the general idea of "selling in May and going away" is not super smart, that there will always be stocks which are worth selling, as it is "a market of stocks, not a stock markets", a quote which I will continue to use and abuse until we forget that Chuck Carnevale made it popular on Seeking Alpha (just kidding, thanks for the wisdom, Chuck).
These are two stocks which are overvalued and investors would be well served selling.
Note that both these stocks are stocks in our coverage, which means that we believe that they are well run, shareholder friendly dividend paying companies, only that at the current prices, investors would be better served selling, and finding a better use for their capital.
Sell Williams-Sonoma
Had I known where the stock price was going when we were accumulating a position in Williams-Sonoma (WSM) between April and June last year, at average prices of $120... I would have loaded up the truck.
Of course, you never know these things, but I believe it is fair to say that our WSM stock has had a fantastic run.
In April 2023, I said:
Growth levers seem to be readily available to the company in the coming decade.
Momentum seems to be turning in the stock's favor.
WSM might be unfairly cheap.
The 17 year dividend history and extremely well covered dividend gives WSM All Weather dividend status, as its focus on affluent well educated homeowners insulates the company somewhat, as research has shown that affluence and education insulates (somewhat) individuals from the impacts of recessions.
For this reason, I believe that right now might be the exact sweet spot to buy WSM, despite it seeming quite contrarian.
My timing is rarely on point, but when it is, I'll tell you, it feels quite good.
Note that this is not a reflection of skill, but more a reflection of the fact that a certain number of stocks I pick will likely be bought at exactly the right time. Certain will be bought at exactly the wrong time. I try to minimize this, but with markets there are things which are beyond my control.
Nonetheless, since then, WSM is up by 137%, which is significantly better than the S&P 500's return over that period.
The facts are that WSM has, in fact, reported a very good quarter once again, delivering a sizeable EPS beat, on the back of vastly improved gross margins and supply chain costs.
Williams-Sonoma's dividend growth has been remarkable, as it is operating from a low dividend base relative to earnings. In the past 12 months, they only paid 20% of FCF as a dividend. This does give plenty of runways for high dividend growth even with low revenue and earnings growth.
However, revenues are down, and are set to be flattish for the full year, as Pottery Barn continues to see very poor comps. High ticket furniture sales are not high on the list of households, and likely won't be for the next few years.
We have now sold the majority of our WSM stake, and are holding on to a small position, which we'll sell if things really get crazy.
Sell Merck
Remember when I said our method wasn't foolproof? Merck (MRK) is a good example of this. We decided to sell our position in different increments between $95 and $110 in 2023.
Between May 2023 and December 2023, when we saw Merck go from $118 to $100, we thought our timing had once again been spot on... Wrong!
Merck rallied 30% this year, reaching a new ATH of $131.75 in March, which it is currently testing again.
And all healthcare stocks have their cycles of greed and fear, as the market tries to anticipate how loss of exclusivity of top drugs might impact top lines, and conversely as they anticipate how new drugs will lead to increased revenues.
We saw this with AbbVie (ABBV) with the scare over replacing Humira sales. We saw it with Pfizer (PFE), first with the euphoria over Covid sales, now the fear over the LOE wall. Bristol-Myers Squibb (BMY) is also undergoing its extended period of market fear.
After years of subpar returns, Amgen (AMGN) is now rallying also as the Horizon integration is showing to be accretive, and the market is excited about some GLP-1 outcomes.
Now is Merck's day in the sun. Its top drug Keytruda got 14 new approvals in 2022, 15 in 2023, and another 3 this year, extending the exclusivity of its drug for different uses.
All I know is the pendulum always swings, and nothing is new under the sun in the healthcare industry.
Looking at MRK's 20 year DFT chart (the same idea but double the period) shows that the pendulum has swung back and forth in the past, with valuations in 2008 relative to the dividend not being too far off from today's.
Of course, those with longer memories will recall that in the 2000 bull market (I don't remember this, I was still a young boy) it yielded as little as 1.45%.
The market is clearly excited about Merck, and the stock is part of the top 5 winners in the Dow Jones during the index's past 10K climb between 30K and 40K.
So, of course, Merck could continue to increase further. It could maybe even go all the way to $200 on crazy exuberance. But smart dividend investors would be well served to look elsewhere because at a 2.3% yield, you're just not getting paid enough to get compensated.
If you fear missing out on the ride up, take a gradual exit from the stock, which is what we usually do. Recently, recognizing that some stocks have been trending way beyond our estimates, we've been keeping a small position to enjoy that juice and not get hit by FOMO.
Conclusion
I hope that this article has managed to entertain, educate, and maybe even inform on a handful of topics: seasonality within the calendar year, return to the mean for dividend stocks, and how to capitalize on such opportunities.
I think this summer will be a good summer for stocks. Let's wait and see, and conservatively harvest overvalued positions and plow them into undervalued positions.
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