Will the summer rally begin in June?6/4/12 12:01 AM ET (MarketWatch)Print
CHAPEL HILL, N.C. (MarketWatch) -- Hope always springs eternal on Wall Street, but especially in June.
So, even though the summer months are a seasonally unfavorable time for the stock market, brokers still come up with plausible-sounding rationales for why gullible clients should nevertheless bet on higher prices. The rationale that always crops up after Memorial Day is the notion of a summer rally.
Unfortunately, as far as I can tell, this notion is pure fiction.
To be sure, in analyzing a summer rally from a statistical point of view, I needed a precise definition. I used a straightforward one: I measured the stock market's gain from the end of May to its highest close during the subsequent three months -- through Aug. 31.
Note that this definition doesn't focus on the market's overall return during the three summer months -- which, as we already know from the volumes of material devoted to the sell in May and go away phenomenon, is lackluster at best. Instead, my definition is based on the highest close anytime between June 1 and Aug. 31, comparing that level to where the market stood at the end of May. To realize such a return, of course, you would have needed to sell on the precise day of that top -- a very tall order indeed.
Qualifications aside, what I found might initially impress you: On average over the last 115 years, the Dow Jones Industrial Average (DJIA) gained an average of 5.25% from the end of May through its highest close over the next three months.
That compounds out to an annualized equivalent of well more than 20%.
Before you rush out to put any of your cash back into the stock market, you should know that, when measured this way, every season of the calendar can boast a rally of similar magnitude.
To illustrate this, for each month of the calendar in addition to May, I calculated the Dow's gain from the end of that month to its highest close over the subsequent three months. It turns out that the average of those other months' "rallies" was 5.24% -- statistically indistinguishable from what it was in the case of the so-called summer rally.
How did anyone ever come to believe in this entirely fictional summer rally? When in prior years I have written about the subject and asked this question of the market historians among you, I was told that one possibility was the extraordinary rally that occurred in the summer of 1932, in the depths of the Great Depression. The Dow nearly doubled during that year's summer's rally.
Without outlier years like that one, the summer rally loses even more statistical support. Since 1940, for example, the average Dow gain from the end of May to its highest close over the next three months is just 4.0%, markedly lower than the average rally in other months of the year.
The bottom line? The next time someone refers to a summer rally while trying to seduce you into increasing your equity exposure, remember that hope is not a strategy.