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BEING STREET SMART

By Sy Harding

SELL IN MAY AND GO AWAY? NOT NECESSARILY!  May 2, 2008.

It's that time again. Twice a year, in the fall and again in the spring, I remind you of the market's amazing seasonal pattern.

The market tends to make most of its gains each year in a 'favorable season' that begins in the fall and ends in the spring, and to experience most of its serious corrections, bear markets, and crashes in the opposite 'unfavorable season' that begins in the spring and ends in the fall.

It's a pattern long known, as indicated by the age-old Wall Street slogan 'Sell in May and Go Away'.

However, previous research on seasonality was generalized. Apparently using only month end research, it determined that to take advantage of the seasonal pattern an investor should enter the market on October 31 each year and exit on May 1, staying in cash from May 1 until the following October 31. The result was a strategy that approximately matched the market's performance over the long-term, while taking only 50% of market risk (by virtue of being out of the market six months each year).

However, we discovered that far from being a six-month in, six-month out seasonal pattern, the favorable and unfavorable seasons could vary in length from four months to seven months. And that the basic calendar days for entries and exits were not at month ends, but on October 16 for the entries, and April 20 for the exits.

But obviously the market does not begin a rally on the same day in the fall every year, nor does it begin a correction on the same day in the spring every year.

So we concentrated on developing a method by which the entries and exits could be more accurately determined each year. We ultimately discovered that a technical indicator known as MACD (developed by Gerald Appel in the 1980s) could be used in combination with the calendar dates to achieve our goal.

The rule is that if MACD is on a buy signal when the October 16 calendar date for seasonal entry arrives, we will enter at that time. However, if the MACD indicator is on a sell signal when October 16 arrives, indicating a market decline is underway, it would not make sense to enter before that decline ends just because the calendar date has arrived. Instead, our Seasonal Timing Strategy waits to enter until MACD gives its next buy signal, indicating the decline has ended.

We use the same method to better pinpoint the end of the market's favorable period in the spring. If MACD is on a sell signal when the calendar exit day of April 20 arrives, we exit then.  However, if the technical indicator is on a buy signal, indicating the market is in rally mode when April 20 arrives, it makes no sense to exit the market just because the calendar date has arrived. So our Seasonal Timing Strategy's 'exit rule' is to remain in the market until MACD triggers its next sell signal, indicating the rally has ended.

Using this strategy we are able to take advantage of the fact that the market's favorable and unfavorable seasonal vary significantly from year to year, sometimes being as brief as four months, other times lasting as long as seven months.

The results? Back-tested over the previous 60 years the strategy significantly out-performed the market, with just two trades a year and with roughly 50% of market risk.

In real-time in my newsletter, over the last nine years (from 1999 through 2007), the strategy provided a compounded total return of 143%, doubling and quintupling the compounded return of 72% for the Dow, and 20.9% for the Nasdaq over the same period. Significantly, it had no down years even in the severe 2000-2002 bear market.

By coincidence, Mark Hulbert, of Hulbert Financial Digest fame, has a column on the market's amazing annual seasonal pattern on Market Watch this week. I am humbled that the column is devoted mostly to reporting the performance of my Seasonal Timing Strategy, comparing it to the old 'Sell In May and Go Away' slogan, as well as to the performance of a well-known newsletter (which he names) that attempted to usurp my strategy as its own, but has performance which Hulbert describes as "significantly inferior to Harding's".

Hulbert notes that he has only been tracking the performance of my strategy since 2002, but that during that time it produced a market beating annualized gain of 8.7%, compared to 6.7% for a buy and hold strategy (and 5.5% for the competing newsletter that adopted my strategy as its own).

Meanwhile, Mark notes in his article that our competing newsletter's 'Six Months Plus MACD' seasonal strategy exited the market in early April, more than 5% below the market's current level, and the 'Sell in May and Go Away' strategy would have had you exit on May 1. But he says, "If you are willing to gamble on a newsletter that has a good track record [on seasonal timing], you will be giving the market the benefit of the doubt for awhile longer".

And that is true. My Seasonal Timing Strategy remains fully invested, and could remain so well into May or June.

But as I warn every spring, we have entered the period when it usually pays not to become too complacent. The market's next unfavorable season can begin at any time once April 20 has arrived.

You can read Mark Hulbert's complete column on MarketWatch by clicking here. http://www.marketwatch.com/news/story/market-timers-attempt-improve-halloween/story.aspx?guid=%7B7923307E%2D00C4%2D4779%2DAC6C%2D11F8805C99FC%7D&dist=msr_4

Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of www.streetsmartreport.com and the free daily blog www.syhardingblog.com. He also authored 1999's timely book Riding The Bear - How To Prosper In the Coming Bear Market.

He has a new book out, Beat the Market the Easy Way - Surprising Seasonal Strategies that Double the Market's Performance. Autographed copies are available at discount from his website for same day shipment.