Sell in May and Go Away, and Luck

by JDH on May 2, 2009

Welcome to the month of May. Before I talk about getting lucky (and no, sorry, it’s not what you think), I would like to comment on the discussion over on the Forum about “Sell in May and away”. You can pick up the thread on selling in May here. Is it true? Should you sell in May and go away? The theory goes that stock traders start selling in May and paying less attention to the markets as they start playing more golf, spend time at the cottage, and go on summer vacation. It makes sense, but is it true?

Here is a chart of DML.TO – Denison Mines Corp. from 2004 through 2008; short term peaks happened on March 26, 2004, April 1, 2005, March 3, 2006, May 11, 2007, and June 6, 2008 (click on the chart to see a bigger version).

I interpret from this that the spring peak can happen anywhere from the beginning of March through to the first week of June, with drops thereafter. So, sell in May is a good, but imprecise, rule. “Sell in spring” would be more accurate, but it’s such a general rule that it may be of no use. A further caveat is that I only pulled up Denison’s chart; other stocks may yield different results, so I encourage you to do your own research. (I did pull up a few other charts in other industries, and a quick look indicates that they all do follow a pattern similar to Denison’s, although not identical).

Since we have had a good run over the last month or two, my bias today is to take profits. If the market continues upward, at least I took profits. If it falls, I am even happier I took profits. So, on Friday I sold all of my remaining shares of Denison, at a very nice profit (more than a double).

I have also reduced my exposure on gold shares, and will start selling my silver shares as well (also at a profit). My plan is to raise cash, probably up to 85% of my portfolio.

Yes, I know, you are all thinking that I’m nuts. We hit the bottom last November, everything is on the upswing, it’s all good from here, and I’m selling. What an idiot I am.

Maybe.

Or, maybe, we need to retest the lows again before we can truly say we are in a new bull market. Perhaps the bankruptcy of Chrysler this week is not a sign of good things to come. Unemployment remains high. Foreclosures are still very high. Government spending is monstrous. Those are not generally leading indicators of a bull market.

Since the late spring and summer months tend to be weak, being in cash is prudent, so that’s what I’m doing. Now, let’s talk books.

JDH’s Book Report – Outliers

Remember when you were in school you had to read books and do book reports?

Today, I present to you the first ever JDH book report. I’m not much of a book reader, so don’t worry, this won’t be a weekly feature.

I would, however, like to comment on Outliers, “The Story of Success” by Malcolm Gladwell. Mr. Gladwell is a staff writer for The New Yorker. More impressive, his father is a professor at the University of Waterloo, so Malcolm spent some of his formative years in the sleepy town of Elmira, Ontario, a short drive from where I spend many days at my real job.

The premise of his book, if I may summarize, is that to be successful you need to be smart, hard working, and lucky.

We all agree with the first two attributes: smart and hard working. But luck?

Yes, luck is a key component to success. He starts the book with a typically Canadian example: the vast majority of professional hockey players were born in January, February or March. Why? Because when five year old kids are learning to skate, the older kids (born early in the year) do better. Being a few months older at age five makes a big difference. Those “better” kids get put on the “rep” team, that practices more and plays more games, so those kids get even better. And so it goes, throughout their formative years. More practice, so they get even better, so they get picked for the better teams, so they get better.

Of course those kids must still work hard and have some basic talent, but it is a fact that being born early in the year helps.

Mr. Gladwell gives numerous other similar examples. Bill Gates went to one of the few high schools in the world in the late 1960’s that actually had a computer terminal. He was able to get time on that terminal learning programming. He worked extremely hard, well into the night, and he was obviously very smart. But if he had not had access to that computer terminal, he would not have founded Microsoft.

Hard work and brains are important, but luck is equally important.

(For more, go to Amazon and buy Outliers: The Story of Success, or borrow it from the library; it’s a quick read).

So, why am I doing book reviews? Do I honestly think you will go to Amazon and buy a $15 book so I can earn 20 cents in commissions?

No, I don’t.

But I do think luck is important. My portfolio was up 52% in 2005, and 94% in 2006. I assumed I was a genius. I had figured out the stock market. I would retire by 2010 and live a life of leisure. Then came 2007, when I lost 33%, and 2008 when I dropped a further 45%. I ended 2008 back where I started 2005.

It turns out I was not a genius. I was lucky. If you bought stocks in the uranium sector in 2005 and 2006, you made money. If you put a list of all uranium stocks on a dart board and picked stocks to buy by throwing darts, you made money. Yes, I did research and analyzed stocks and was in the right sector at the right time, but then I was lucky, just like Malcolm Gladwell’s hockey players and Bill Gates.

If I truly was brilliant I would have continued to earn huge returns in 2007 and 2008, instead of giving it all back. Had the fundamentals for uranium changed? Was the energy crisis solved in 2007, such that nuclear power will no longer be necessary? Is global warming done? No, but markets get inflated and deflated, and if you are buying during the inflation phase you make money, and if you are holding during the inevitable sell off, you lose.

Let me say that again: during a bull market, stocks go up. Pick any stock, and it will, on average, go up. If you pick the leading industry group (like uraniums in 2006), virtually any stock in that industry will go up. You have to be smart to get the industry right, but you have to be lucky to be buying during a bull market.

The opposite is also true. You can be the best technical analyst in the world, and you can pick the stock with the best RSI or MACD or stochastics, and you can buy it, and if a bear market starts, you will get killed.

So what can we do? Should we just give up, and hope for luck? Is it pointless to do research and technical analysis?

No, I think hard work is very important. Understanding the markets are very important. But don’t believe your own press clippings. Don’t fool yourself into believing that just because you bought a stock and it went up that you are automatically a brilliant stock picker. You may be, or you may be lucky.

I met with a number of people this week who told me exactly the same story: They bought a bigger house two or three years ago, with very little money down. All was good until they lost their job, or their hours got cut back at work. Now if they sell their house and pay the real estate commissions, legal fees and penalties to break the mortgage, and pay off the mortgage, they will lose $20,000. Or $50,000. They thought buying “up” was a wise financial move because every knows that house prices always go up, and now they are on the verge of bankruptcy because house prices have crashed.

You are a brilliant real estate speculator if you buy at the start of a bull market, and you risk personal bankruptcy if you buy at the peak. Luck is funny that way.

The Toronto Star ran a story this morning titled Generation Why Me? that talks about young people who thought they were doing the right thing by buying a home and getting an education, but with rising youth unemployment they are now losing their homes. They are depressed thinking about the future. They are not out there buying goods and services, they are not driving the economy forward, because they can’t. People cutting back is not a recipe for future growth.

As I watch people walk away from their homes, and as I watch continued increases in unemployment, and as I watch marriages deteriorate due to financial pressures, I am not optimistic about the short term health of the North American economy. Government spending will not help; it will crush us in the medium term. And swine flu, or whatever they are telling us to call it now, probably won’t help either.

As I stare at the chart of the Dow, I do not see a pretty picture. Let’s not forget the “bottom” of 7,552 on November 20, 2008 was followed by another “bottom” of 6,547 on March 9, 2009. Is that the last bottom?

We all thought happy days were here again when the Dow jumped from the “bottom” of 7,552 on November 20, 2008 to 8,934 on December 8, 2008, a gain of over 18%, and the start of a new bull market. By January 2 we were over 9,000. We all know what happened from there. We crashed, again.

Luck in stock market investing starts with guessing whether or not we are in a bull or bear market. In a bear market virtually everything goes down, notwithstanding some temporary bear market bounces. I believe we remain in a bear market. Until we stop making new lows, we are in a bear market.

And that’s why I’m moving even more of my portfolio into cash. The long term charts show conclusively that we are in a bear market. The seasonality of “sell in May and go away” leads me to believe that selling now is prudent. The horrible fundamentals of the economy tell me that there is more bad news to come.

Of course I could be wrong. It is accepted wisdom that the stock market is a leading indicator. The stock market today tells us what the economy will be doing six months from now, so the theory goes. The market has done great for the last six weeks, so the economy will be doing great by the end of the year. Or, we are in a dead cat bounce, and it won’t. I’m betting on the latter.

I’m not ready to start shorting anything yet. If I’m wrong and the market picks up, I leave profits on the table. If I short and the market picks up, I lose money, so for now I will watch and observe.

As always, thanks for reading, and feel free to comment on whether or not you think I’m crazy over on the Buy High Sell Higher Forum. See you next week.