The Optimism Cycle: Sell in May

Summary  On average, stocks deliver close to zero returns from May through October. We hypothesize that this seasonal pattern is caused by an optimism cycle. With year end approaching, investors start to look towards next year, often with overly optimistic expectations. Several months into the year, the initial optimism becomes hard to maintain and the stock market experiences a summer lull. A global sector-rotation strategy based on this theory appears to be highly profitable. Global earnings growth revisions follow a seasonal pattern parallel to that of the stock market. Investors’ optimism as measured by the initial returns on IPOs almost completely captures the results of the sector-rotation strategy in a separate analysis for the US stock market. All these findings support the optimism-cycle hypothesis. The author is grateful to Steef Bergakker for all the useful discussions about market dynamics through the years, which have contributed to the theory that an optimism cycle might exist. Special thanks go to Marno Verbeek for his very helpful suggestions. This paper also benefited from the remarks and suggestions from two anonymous referees.