A Timely Seasonal Switching Strategy that Beats the Market with Reduced Volatility

Last year was another cruddy year for active equity managers.

According to the S&P Dow Jones SPIVA 2016 scorecard:

  66% of large-cap managers …

  89% of mid-cap managers …

  And 86% of small-cap managers …

Underperformed the S&P 500, S&P MidCap 400 and S&P SmallCap 600, respectively.

That may sound bad. But, it’s even worse over the longer term …

Source: SPIVA scorecard, data as of 12/31/16

As you can see above, 88% of large-cap managers have underperformed the S&P 500 Index over the last five years.

Yet, it’s even worse for smaller-sized stocks …

Since 2011:

  90% of mid-cap managers have underperformed the S&P MidCap 400 Index.

  And 97% of small-cap managers have underperformed the S&P SmallCap 600 Index.

Curious about even longer-term returns?

It’s still ugly.

Over the last 10 years, underperformance checks in at 85% (large-cap managers), 96% (mid-cap managers) and 96% (small-cap managers). And going back 15 years, outperformance is still painfully high at 92%, 95% and 93%, respectively.

One thing’s for sure …

It’s extremely difficult for professional investors to outperform their benchmarks over any period.

But, I have a simple strategy that’s historically bucked this trend …

It’s from my colleagues at The Leuthold Group.

[For those of you who haven’t heard of The Leuthold Group, they’re one of the top institutional research firms in the world. (I’m honored to have access to their information.) Leuthold uses proprietary data to do extensive research on financial markets. Individual investors, financial advisers and institutions can view the firm’s product offerings — mutual funds and separately managed accounts — here.]

Leuthold has found a simple way to skirt the poor prospects of active management and beat the benchmark.

Their approach to outperforming the market is tied to the "Sell in May" phenomenon.

The time-honored "Sell in May" trading adage warns investors to liquidate their stock holdings in the month of May to avoid a seasonal drop in equity prices. Then, it urges them to get back into stocks in November.

The goal is to skip the worst six months for stocks (May-October), but be fully invested during the market’s strongest six months (November-April).

Historical data supports this old adage …

S&P 500 annualized returns during the stronger November-to-April span have been roughly 2X the weaker May-to-October stretch.

But, what few investors know is the "Sell in May" effect is even more pronounced in small caps …

The same study for small caps shows a 10-to-1 performance variance over the last 91 years!

Plus, the combination of the Ibbotson SBBI and Russell 2000 (benchmarks for small caps) also easily outpaced the S&P 500 during the dominant November-to-April interval, +21.2% vs. +13.4%.

The market historians at Leuthold have honed in on a market-beating strategy connected to the "Sell in May" pattern …

We’ll call it "Switch in May" instead.

Here’s a chart depicting their calendar strategy:

In this month’s "Perception Express," Leuthold said:

The seasonal pattern has been so powerful that one could have actually beaten the Small Cap "buy-and-hold" approach by moving assets into Treasury bills during the May through October period. Since 1926, this strategy has generated an annualized return of +12.0% versus +11.3% for the Small Cap Total Return Index. The standard deviation of the active strategy is 18.6% versus 28.3% for buy-and-hold, thanks to the six month intervals when the portfolio is safely parked in cash.

Not only is this strategy easy to understand, it’s also easy to execute.

For the small-cap stock component (November-April), an investor could use an ETF such as the iShares Russell 2000 ETF (IWM).

And for the safe Treasury bill component (May-October), investors could sit in cash or cash equivalents, buy an actual T-bill or invest in an ETF like the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), the Goldman Sachs TreasuryAccess 0-1 Year ETF (GBIL), the iShares Short Treasury Bond ETF (SHV) or the PIMCO Enhanced Maturity Active ETF (MINT).

Keep in mind, the short-term fixed-income ETFs may not be perfect substitutes.

Next time you’re ready to "Sell in May," consider "Switch in May" as an alternative.

Grant Wasylik

Your thoughts on “A Timely Seasonal Switching Strategy that Beats the Market with Reduced Volatility”

  1. From your charts the S&P500 gained 3.4% from May – Oct. and 6.7% from Nov. – Apr. which adds of to 10.1% if one stayed in the S&P500 for the entire year.
    And the small Caps gained 1.05% from May – Oct and 10.6% from Nov – Apr which adds up to 11.65% if one stayed in the small Caps for the entire year.
    However is one invested in the S&P500 from May – Oct with a gain of 3.4% and then invested in the small Caps from Nov, – Apr. with a gain of 10.6% which adds up to 14% for the year which is even better!
    Or am I missing something? Al

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Originally from Pennsylvania, Grant graduated from Juniata College with an economics major and accounting minor. Since graduation, Grant has worked in the investment industry for almost two decades by serving in various roles … Prior to coming to…