The Optimism Cycle: Sell in May

Abstract

The market maxim "Sell in May and go away" is a simple but profitable one. On average, stocks deliver close to zero returns in the six month period from May through October, only giving a risk premium from November through April. This effect, however, has not been widely covered in academic literature. We examine the hypothesis that the seasonal pattern is caused by an optimism cycle. Towards year end, investors start to look towards the new year, often with overly optimistic expectations. This results in attractive returns for stocks. Several months into the year, this initial optimism becomes hard to maintain and the stock market experiences a summer lull. A zero-investment global sector-rotation strategy based on this theory appears to be highly profitable. Global earnings growth revisions also follow a seasonal pattern parallel to that of the stock market. Finally, in a separate analysis for the US stock market, investors' optimism as measured by the initial returns on IPOs almost completely capture the results of the sector-rotation strategy. All these findings support the optimism-cycle hypothesis.

Keywords: earnings revisions, optimism cycle, psychology, seasonality, sell in May

JEL Classification: G12, G14, G15