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The Search for Yield During the Off-Season for Stocks

Jon Vialoux

The Search for Yield During the Off-Season for Stocks

Snapshot
An analysis of historical equity market performance shows the “Sell in May and Go Away” strategy fails to deliver alpha over time. Investors should instead look to income generation strategies, with a focus on assets that have been tested for dividend growth and sustainability, in order to outperform the benchmark during the off-season for stocks.   

Details
BMO Canadian High Dividend Covered Call ETF (Ticker: ZWC)
BMO US High Dividend Covered Call Hedged to CAD ETF (Ticker: ZWS)
BMO Covered Call Canadian Banks ETF (Ticker: ZWB)
BMO Covered Call Utilities ETF (Ticker: ZWU)

Benefits
Defensive growth. Income generation. Long-term outperformance.   

Trade Idea – The Seasonal Advantage
Let the rhetoric pertaining to “Sell in May and Go Away” begin. Interest in the strategy continues to grow due to the sheer simplicity that the strategy entails. However, a simple back-test shows that it has failed to deliver alpha over time. An investment of $10,000 in the S&P 500 Total Return Index 25 years ago would be worth $87,719 as of the end of 2018, far surpassing the “Sell in May” portfolio that grew to $53,332. The latter entails holding the broad market benchmark for only six months of the year between the end of October and the start of May. The annual return of the buy-and-hold approach has matched or outperformed the performance of the “Sell in May” strategy in 19 of the past 25 years with only the returns surrounding the last two recessions providing a benefit to the cash heavy mandate (see chart below). The analysis incorporates the impact of dividends, but excluded the calculation of commissions and any tax consequences that would accompany selling positions at the end of April and buying back in October. 

bmo-etfs_06SP500chart848px_2019-06-09_ENG.jpg#asset:2907

The theory suggests that there is little value in attempting to time the market, but within the results, a key takeaway can be derived. The period between October and May has historically been best suited for capital gain strategies, while income-oriented strategies have typically been beneficial in the other half of the year. Since 1950, the S&P 500 Total Return Index has gained an average of 6.99%, excluding dividends, in the favourable time of year for stocks, while the other half has returned an average of 1.49%.1 It is during the off-season for stocks that income-generation strategies often outperform the average market performance. Historically, this has entailed buying defensive sectors, whether it be consumer staples, utilities, health care, or REITs, which typically provide higher yields than the rest of the market. ETFs make the process of yield enhancement simpler than ever. Strategies that focus on a basket of stocks that have been tested for dividend growth and sustainability are complemented with option overlays that will provide an additional yield of around 2% above the return of the core portfolio. The “flattish” tape that defines the average seasonal profile of the broad equity market between May and October is the ideal environment for covered call strategies, as the call option has a greater chance of expiring worthless, allowing the writer (the fund) to retain the full value of the premium. We use BMO ETFs to execute this strategy via ZWC, ZWS, ZWB and ZWU. Each has a listed annualized distribution yield within the range of 5% to 7%,2 much stronger than the current yield of the S&P 500 Index of 1.90%.3 Not only are these portfolios composed of equities that exhibit positive seasonal tendencies through the summer months, but the yield enhancement provided by the covered-call overlay helps to offset volatility that is typical of market performance through the third quarter of a given year.

bmo-etfs_07IndexSeasonalitychart848px_2019-06-09_ENG.jpg#asset:2903


Jon Vialoux is the author and Founder of EquityClock.com, which offers the largest source of seasonal analysis for investments on the Internet. He is also co-founder of the financial resource website, TimingTheMarket.ca, which offers technical, fundamental, and seasonal analysis of the markets. Jon is a registered Associate Portfolio Manager at CastleMoore Inc.

 

 

1 EquityClock.com.

2 The payment of distributions is not guaranteed and my fluctuate. The payment of distributions should not be confused with a fund’s performance, rate of return, or yield. If distributions paid by the fund are greater than the performance of the fund, your original investment will shrink. Distributions paid as a result of capital gains realized by a fund, and income and dividends earned by a fund are taxable in your hands in the year they are paid. Your adjusted cost base will be reduced by the amount of any returns of capital. If your adjusted cost base goes below zero, you will have to pay capital gains tax on the amount below zero.  Please refer to the fund’s distribution policy in the prospectus.

3 Bloomberg, as of May 23, 2019.

Jon Vialoux

The Search for Yield During the Off-Season for Stocks

Snapshot
An analysis of historical equity market performance shows the “Sell in May and Go Away” strategy fails to deliver alpha over time. Investors should instead look to income generation strategies, with a focus on assets that have been tested for dividend growth and sustainability, in order to outperform the benchmark during the off-season for stocks.   

Details
BMO Canadian High Dividend Covered Call ETF (Ticker: ZWC)
BMO US High Dividend Covered Call Hedged to CAD ETF (Ticker: ZWS)
BMO Covered Call Canadian Banks ETF (Ticker: ZWB)
BMO Covered Call Utilities ETF (Ticker: ZWU)

Benefits
Defensive growth. Income generation. Long-term outperformance.   

Trade Idea – The Seasonal Advantage
Let the rhetoric pertaining to “Sell in May and Go Away” begin. Interest in the strategy continues to grow due to the sheer simplicity that the strategy entails. However, a simple back-test shows that it has failed to deliver alpha over time. An investment of $10,000 in the S&P 500 Total Return Index 25 years ago would be worth $87,719 as of the end of 2018, far surpassing the “Sell in May” portfolio that grew to $53,332. The latter entails holding the broad market benchmark for only six months of the year between the end of October and the start of May. The annual return of the buy-and-hold approach has matched or outperformed the performance of the “Sell in May” strategy in 19 of the past 25 years with only the returns surrounding the last two recessions providing a benefit to the cash heavy mandate (see chart below). The analysis incorporates the impact of dividends, but excluded the calculation of commissions and any tax consequences that would accompany selling positions at the end of April and buying back in October. 

bmo-etfs_06SP500chart848px_2019-06-09_ENG.jpg#asset:2907

The theory suggests that there is little value in attempting to time the market, but within the results, a key takeaway can be derived. The period between October and May has historically been best suited for capital gain strategies, while income-oriented strategies have typically been beneficial in the other half of the year. Since 1950, the S&P 500 Total Return Index has gained an average of 6.99%, excluding dividends, in the favourable time of year for stocks, while the other half has returned an average of 1.49%.1 It is during the off-season for stocks that income-generation strategies often outperform the average market performance. Historically, this has entailed buying defensive sectors, whether it be consumer staples, utilities, health care, or REITs, which typically provide higher yields than the rest of the market. ETFs make the process of yield enhancement simpler than ever. Strategies that focus on a basket of stocks that have been tested for dividend growth and sustainability are complemented with option overlays that will provide an additional yield of around 2% above the return of the core portfolio. The “flattish” tape that defines the average seasonal profile of the broad equity market between May and October is the ideal environment for covered call strategies, as the call option has a greater chance of expiring worthless, allowing the writer (the fund) to retain the full value of the premium. We use BMO ETFs to execute this strategy via ZWC, ZWS, ZWB and ZWU. Each has a listed annualized distribution yield within the range of 5% to 7%,2 much stronger than the current yield of the S&P 500 Index of 1.90%.3 Not only are these portfolios composed of equities that exhibit positive seasonal tendencies through the summer months, but the yield enhancement provided by the covered-call overlay helps to offset volatility that is typical of market performance through the third quarter of a given year.

bmo-etfs_07IndexSeasonalitychart848px_2019-06-09_ENG.jpg#asset:2903


Jon Vialoux is the author and Founder of EquityClock.com, which offers the largest source of seasonal analysis for investments on the Internet. He is also co-founder of the financial resource website, TimingTheMarket.ca, which offers technical, fundamental, and seasonal analysis of the markets. Jon is a registered Associate Portfolio Manager at CastleMoore Inc.

 

 

1 EquityClock.com.

2 The payment of distributions is not guaranteed and my fluctuate. The payment of distributions should not be confused with a fund’s performance, rate of return, or yield. If distributions paid by the fund are greater than the performance of the fund, your original investment will shrink. Distributions paid as a result of capital gains realized by a fund, and income and dividends earned by a fund are taxable in your hands in the year they are paid. Your adjusted cost base will be reduced by the amount of any returns of capital. If your adjusted cost base goes below zero, you will have to pay capital gains tax on the amount below zero.  Please refer to the fund’s distribution policy in the prospectus.

3 Bloomberg, as of May 23, 2019.