“Sell in May and Go Away” is one of those old market adages that, over time, is substantiated by a rather meaningful performance bias. The observation behind the adage is that US equity markets tend to be weak during the six month period from May through October, or at least much weaker than they have been during the “strong” six months of the year. While this is something that hits close to home for investors, given that we have just turned the calendar to the month of May, it is also not an investing approach that comes without its failures. Last year, for instance, the Dow Industrials gained nearly 5% during the seasonally weak stretch, while the S&P 500 was up 9.95% from April 30, 2013 to October 31, 2013. Seasonality refers to a bias, but clearly not all May-through-October time periods result in major corrections or seismic market events. For this reason, despite the historic bias, many investors simply won’t embrace a “pure tactical” switching strategy (all in, or all out) that is tied to a calendar. They may instead be open to the concept of a seasonal “tilting” approach that employs “smart beta” investment options.
Two such smart-beta products that we refer to often due in part to their complementary relationship over time are the PowerShares DWA Momentum Fund [PDP] and PowerShares Low Volatility Fund [SPLV]. These two products are based upon very different return factors (High RS & Low Volatility), and as a result tend to have very different holdings. Each fund targets exposure to 100 stocks, and currently there are only 8 holdings common to both funds. That said, when put together these funds tend to have a complementary relationship, producing solid long-term returns, with fairly low correlation of excess returns. As we show in the graphic below, an index that simply owns 50% PDP and 50% SPLV over time has produced hypothetical annual performance roughly 200 bps better than the market with volatility less than the market (SPX). This combination makes for a very attractive US “core” equity solution, or perhaps a starting point for a seasonal “tilting” strategy.
So as we hit May and the beginning of the historically “seasonally “weak” period for Equities, now is the time to think about positioning your portfolios accordingly. “Tilting” seasonally, using a combination of low-volatility and Technical Leaders ETFs, is a powerful way to do that. With that said, we wanted to spend some time discussing a concept that we introduced last year, and that is the combination of the PDP and SPLV, rebalanced biannually based on market seasonality.
While the numbers of the “Six Month Switching Strategy” are eye-popping, and the allure of coming to work twice a year to buy the market the first of November and then sell the market the first of May might conjure up dreams of sitting on a tropical island for the other 363 days, the practical application of such a strategy leaves a bit to be desired. Therefore, today we wanted to present you with a practical portfolio application that you could utilize as a part of your overall equity exposure through the seasonally strong six month period as well as the seasonally weak.
The backdrop for our strategy all lies in the historical bias that having exposure to the market during the seasonally strong six months is a good thing, and having exposure to the market during the seasonally weak period has caused more headache than actual return. Also, the idea of being completely out of the market for an entire six months every single year is not likely to get you excited, let alone being prudent from a compliance standpoint. With that said, we want to generally have an overweighted position to the strongest areas of the market during the seasonally strong period, and an overweighted exposure to the more defensive, lower volatility names during the seasonally weak period. Therefore, in our study we tested a portfolio that owned both the PowerShares DWA Technical Leaders Index [PDP] along with the PowerShares S&P Low Volatility ETF [SPLV]. During the seasonally strong six months (Nov 1- Apr 30) our portfolio would be 70% PDP and 30% SPLV and during the seasonally weak six months our portfolio would be 30% PDP and 70% SPLV.
As you can see in the table below, the SPLV has generally provided greater returns during the seasonally weak six months (cumulative of 25.33% since 4/30/1997) than the PDP (-2.70%). However, the SPLV has notably lagged the return of the PDP during the seasonally strong six months, up 127.08% compared to 597.42%, respectively. Therefore, a 30% PDP/70% SPLV split during the seasonally weak six months has seen a cumulative return of 20.22%, while a 70% PDP/30% SPLV split during the seasonally strong six months has seen a return of 435.80%.
