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"Selling in May and not going away?" by MarkHulbert

Commentary: At least one follower of the Halloween Indicator is not selling

By Mark Hulbert, MarketWatch
Last update: 12:01 a.m. EDT April 30

ANNANDALE, Va. (MarketWatch) -- Wednesday marks the end of the positive seasonal pattern that goes by the name of the Halloween Indicator.

It is a very powerful pattern indeed, as you no doubt will be hearing repeatedly over the next few days: The stock market historically has produced almost all of its average returns during the six months between Halloween and the end of April. Its average return between May Day and Halloween, in contrast, is close to zero. That's why this pattern also goes by the name of "Sell in May and Go Away."

That record certainly implies that you might want to get out of the market at Wednesday's close. But at least one close follower of the Halloween Indicator is not doing that. And he has the track record to suggest we pay him close attention.

I'm referring to Sy Harding, editor of a newsletter called Sy Harding's Street Smart Report. Each autumn and spring he tinkers with the precise days on which a follower of the Halloween Indicator should get into and out of the market.

Harding relies on a technical indicator known as MACD to pinpoint those days. MACD stands for moving average convergence divergence. It is a short-term momentum indicator, created several decades ago by Gerald Appel, editor of the Systems & Forecasts newsletter. It compares the relative movements of several moving averages of different lengths.

This sometimes leads Harding into deviating by quite a few weeks from the traditional entry point of Oct. 31 and exit date of April 30. Last fall, for example, Harding didn't recommend that followers of the Halloween Indicator get back into the market until late November, nearly a month into the positive six-month seasonal period. Harding was amply rewarded for his decision to wait, as his re-entry price was more than 5% lower than it would have been had he mechanically followed the Halloween Indicator and bought at the close on Oct. 31 (as judged by the Dow Jones Wilshire 5000 index (97199001:Dow Jones Wilshire 5000 Composite Index Last: 13,991.12-41.42-0.30% 5:26pm 04/30/2008

The Hulbert Financial Digest has been tracking, since May 31, 2002, Harding's record in deviating from the strict version of the Halloween Indicator, and on average he has done markedly better. The HFD calculates his track record on the assumption that, when he is on a buy signal, he earns the dividend-adjusted return of the Dow Jones Wilshire 5000 Index; otherwise he is assumed to be invested in 90-day Treasury bills.

To put Harding's success into context, consider that since mid-2002, a buy-and-hold in the stock market has produced a 7.5% annualized return (through April 29). A purely mechanical application of the Halloween Indicator (automatically entering the market on Halloween and exiting on May Day) would have produced a 4.5% annualized return. Though this 4.5% return is disappointing, relative to the Halloween Indicator's long-term track record, it is not as bad as it otherwise seems, since it was turned in with half the risk associated with buying and holding the market as a whole. The Halloween Indicator's risk-adjusted return since mid 2002 is close to that of a buy-and-hold.

Now consider the performance of Harding's modification of the Halloween Indicator: It produced an 8.7% return (annualized) over the same period, or 4.2 percentage points per year better than a purely mechanical application of this seasonal pattern -- and 1.2 annualized percentage points better than buying and holding.

What is Harding saying now? In his latest telephone hotline message, he said was giving the stock market the benefit of the doubt because his particular MACD indicator was on a buy signal. So long as that remains the case, he continued, "the exit [from the market pursuant to the Halloween Indicator] could be delayed to as late as May or June if the market's rally off its early March low continues."

For those of you who are tempted to try imitating Harding's success yourself by applying a MACD approach to the Halloween Indicator, here's a cautionary note: Another newsletter that attempts to do what Harding does has performed much more poorly.

I'm referring to the Almanac Investor Newsletter, edited by Jeffrey Hirsch. His particular application of the MACD to the Halloween Indicator got him into the market last fall in early October, at a buy price that turned out to be 5% higher than Harding's. And Hirsch exited from the stock market in mid-April, at a sell price that was more than 4% lower than where the market stands today. (As before, I used the Dow Jones Wilshire 5000 index as the proxy for the overall market.)

This helps to explain why Hirsch's tinkering with the Halloween Indicator has been significantly inferior to Harding's. In contrast to the 8.7% annualized return of Harding's approach since May 31, 2002, Hirsch's has produced a 5.5% return. To be sure, that's 1.0 annualized percentage points ahead of the mechanical Halloween indicator's return over this period, but 2.0 annualized percentage points behind a buy-and-hold.

The bottom line for followers of the Halloween Indicator? If you distrust tinkering of any sort, then you will be exiting the stock market at today's close. But if you are willing to gamble on a newsletter that has a good track of such tinkering, you will be giving the stock market the benefit of the doubt a while longer.