This is an article I wrote in middle of May that was published on Morningstar.

Half way into May, major market indexes have all fallen more than 5% from their peaks reached in late March. The Nasdaq has fallen close to 10%. It looks like the ancient stock market folklore “Sell in May and go away” is quietly unfolding right before our eyes.

To get a better understanding of this phenomenon, I did two things recently: 1) I studied the historical returns between May 1 and Sept. 30 and 2) I pondered a plausible explanation of stock market seasonality and its implication on investment. Today, I will report to you the results of my intellectual exercises.<

Historical returns
Using data retrieved from Yahoo.com, I calculated the average S&P 500 index return between May 1 and Sept. 30 to be -0.3% over the past 20 years. As a comparison, the average index return between Oct 1 and April 30 is 7.2%. Clearly the five months starting in May are unproductive for stock investment, historically.

Why such stock market seasonality?
Many brilliant economic heads have gone bald trying to answer that question. I have a simple behavioral explanation that has not been tested rigorously, but I think it is plausible enough to share with you.

Stock markets are driven by good news and bad news. Before the holiday season – the first holiday being Thanksgiving in November – corporate chieftains and government officials are less inclined to release bad earnings/economic news. Why ruin the holiday? That’s very sensible reasoning. So bad news are swept under the proverbial rug and only good news are released to the public between October and January. That causes the market to rise. The momentum carries on for a few more months after the holidays.

As the spring arrives, all the bad news that was swept under the rug has to be taken out and dealt with: hence, what we are seeing now – European debt crisis AGAIN! – market decline.

Should we get out of the market?
Based on historical evidence, I would not recommend that. In the last 20 years, between May 1 and Sept. 30, 40% of the times the market fell and 60% of the times the market rose. I am going to argue that it is impossible to predict with any measure of accuracy what the market will do this year. It could well rise while you sit out the market.

What can we do about this knowledge?
If you have new money to invest now, spread the investment over the summer instead of putting it all in at once. It’s nice to have this fine-tuning of investment strategy. Still, it’s far more to have a well-diversified investment plan and sticking to it through good seasons and bad.

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