Sell in May and go away – The curious case of international equities

In our previous piece we looked at the old adage of “Sell in May and go away” in US equity markets, and data over the past forty years suggests that it may be time to rethink it. However, the international picture is a little more curious as we shall see below.

International equity market data does not extend as far back as the US data does, and in any case, it would have been hard to implement a switching strategy at low cost prior to the 2000s. In this piece we consider the MSCI EAFE (developed markets excluding US) and MSCI EM (emerging markets) indices between 1988 and 2017, i.e. the last thirty years. The returns are in US dollar terms. We also show S&P 500 returns over this same period for comparison.

Unlike US equities, summer returns for international equities are mixed. As the next exhibit illustrates, average returns for international equities across the May – August periods over the past thirty years have been significantly lower than corresponding returns for US equities. Average returns across the summer are actually negative for international developed equities. Even the relatively low returns for emerging market equities suggests that perhaps switching from international equities to cash may have worked in this case.

Average returns between May and September for S&P 500 (total return), MSCI EAFE index (gross, USD) and MSCI EM index (gross, USD) between 1988 and 2017. Data source: MSCI.

The underperformance is not surprising in the case of international developed equities, which have seen lower returns than US equities over the past thirty years – with a compounded annual return of 5.97%, compared to 10.70% for the S&P 500. On the other hand, emerging market equities outperformed US equities over this period, with a compounded annual return of 11.36% – but significantly underperformed US equities in the summer.

Comparing “Buy and hold” to “Sell in May, come back in September”

Arithmetic averages across thirty summers can tell us only so much and a better approach is to see how a “Sell in May, come back in September” strategy would have performed in developed and emerging markets. Similar to what we did with US equities, the switching strategy compares “Buy and hold” strategies for the MSCI EAFE and EM indices to one that sells the indices at the end of April and buys them back at the end of August. The switching strategy sits in cash during the four summer months – with the Bank of America 1-3 month treasury bill index used as a cash proxy.

The exhibit below indicates that switching away from international developed and emerging market equities would have worked really well across the entire thirty year period. A dollar invested in the MSCI EAFE Index at the beginning of 1988 would have grown to $5.70 by the end of 2017 if you held on to that investment – a compounded annual return of 5.97%. However, the same dollar would have grown to $12.29 by the end of 2017 if you switched to cash between May and September, for a compounded annual return of 8.72% . Switching away from equities to cash also reduced volatility: 14.00% annualized versus 16.79% for “Buy and hold”.

Growth of $1.00 between January 1988 and December 2017 for MSCI EAFE/MSCI EM indices with a “Buy and Hold” strategy and a “Sell in May, come back in September” strategy that switches between the index and Bank of America 1-3 month treasury bill. MSCI index returns are gross and in USD terms. Data source:MSCI

The difference is just as large when you look at emerging market equities. A dollar invested in the MSCI EM index at the beginning of 1988 would have grown to $25.22 by the end of 2017 if you held on, translating to compounded annual return of 11.36%. In contrast, the “Sell in May, come back in September” strategy would have turned a dollar into a whopping $52.11 – a compounded annual return of 14.09%! Again, the switching strategy was less volatile, with a volatility level of 18.89% over the entire period, compared to 22.71% for “Buy and hold”.

The switching strategy appears to have worked for international equities even when you look at recent sub-periods, 2000-2012 and 2013-2017. This is in contrast to US equities, where “Buy and hold” significantly outperformed the switching strategy over the past five years.

Compounded annual returns for S&P 500, MSCI EAFE and MSCI EM indices with a “Buy and Hold” strategy and a “Sell in May, come back in September” strategy (switching between the S&P 500 index and Bank of America 1-3 month treasury bill). Periods: January 2000 – December 2012 (left panel) and January 2013 – December 2017 (right panel). MSCI index returns are gross and in USD terms. Data source:MSCI

Of course, all these returns are purely hypothetical and excludes fees and transaction costs for switching. Making it even more conceptual is the fact that there probably was no cost-effective way to do the switching in international equities for a good part of the period, especially since low cost vehicles tracking these indices were launched only in the early 2000s.

It is hard to speculate why the “Sell in May, come back in September” strategy has seemingly worked for international equities, but not for US equities. It may be the case that this “anomaly” exists, on paper at least, in international equity markets since they are less efficient than US equity markets.

Local currency returns cloud the picture

Now one issue with the results we showed above is that the international equity returns are all in US dollar terms, as are typical low-cost international equity vehicles in the US. If indeed a trading related anomaly existed in international equity markets, it would have to exist even when you consider returns in the local currency.

However, repeating the exercise with returns in local currency terms shows a much more clouded picture.

The switching strategy works for developed international equities over the entire 1988-2017 period, when you consider local currency returns. The compounded annual return for “Buy and hold” is 5.97%, lower than the corresponding 8.74% number for the switching strategy.

However, this is not the case for emerging market equities in local currency, for which “Buy and hold” outperforms “Sell in May, come back in September” over the past thirty years. The compounded annual return for “Buy and hold” is a massive 27.10%, higher than the 24.05% annual return for the switching strategy.

As we noted earlier, these returns were probably unobtainable for the early part of the period due to liquidity and access issue, especially in emerging markets. So let’s consider just the recent sub-periods of 2000-2012 and 2013-2017.

The switching strategy outperforms during the 2000-2012 sub-period for both developed and emerging market local currency equities, as it did for US equities. However, the most recent five years saw “Buy and hold” outperforming across all three asset classes.

Compounded annual returns for S&P 500, MSCI EAFE and MSCI EM indices – “Buy and Hold” strategy and a “Sell in May, come back in September” strategy (switching between the S&P 500 index and Bank of America 1-3 month treasury bill). Periods: January 2000 – December 2012 (left panel) and January 2013 – December 2017 (right panel). MSCI index returns are gross and in local currency terms. Data source:MSCI

One could argue that a seasonal anomaly related to trading would have to show up when you remove the impact of currency, perhaps even more so. This is clearly not the case.

It appears that US dollar appreciation in the summer, especially against emerging market currencies, lowers US dollar based returns. In other words, a stronger dollar in the summer means that US investors see lower returns once losses in the weaker local currencies are converted back to US dollars. This boosts the fortunes of a strategy that sells in May and comes back in September. This has particularly been the case more recently, between 2013 and 2017.

The obvious question is whether there is a real currency related seasonality effect here or if it is simply a random artifact of the dataset we considered in this study – something we will explore in a future piece.

The dispersion between US dollar based returns and local currency returns for international equities suggests that the case for selling in May is far from closed. Also, we considered only the most recent thirty years of data, a period that is ultimately too short to draw any firm conclusions.

 

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