Where will you be if the market takes off?

Buying according to the calendar can be a gamble, says Jenne Mannion. But is it the time to get into equities?

Slump-stricken equity investors can breathe a sigh of relief. The fourth quarter of the year is here, and if you believe financial folk lore that means the outlook for equities should automatically be brighter.

Slump-stricken equity investors can breathe a sigh of relief. The fourth quarter of the year is here, and if you believe financial folk lore that means the outlook for equities should automatically be brighter.

Distinct patterns in stock markets show that equities traditionally deliver better returns at certain times of the year. Hence the old adage: "Sell in May and go away, come back on St Leger Day."

The St Leger - the oldest event on the racing calendar - was run last Saturday. Meanwhile, the summer holidays have ended. The City, which has been almost deserted in recent months, is again buzzing.

Nigel Thomas, manager of the Framlington UK Select Opportunities fund, says the St Leger Day adage dates back to the days when the City took the summer months off work to attend the social season. "City workers would do a circuit including events such as the Henley Regatta, Ascot and ground shooting over August. The classic finale of the season would be the St Leger Day race in Doncaster. After that, everyone returned to their desks on the following Monday, ready to work and trade. That typically meant the market started moving again," he says.

The old adage still seems to be truer than ever today. The summer months are a popular time to take holidays and the City in August is becoming more and more deserted, meaning there are fewer people trading.

But there are also more technical reasons why shares slump in the summer. Mr Thomas says: "The main company year-ends are December and March, which tend to be reported two or three months later. July and August are pretty quiet months for companies, so there is little news to sway share prices either way."

Gavin Haynes, an independent financial adviser at Whitechurch Securities in Bristol, agrees that investors do not tend to react to major corporate news - one of the major drivers of share prices - over the summer months. "Share prices are very non-volatile and there is little sentiment either way. It is a good time to be out of the market," he says.

So is it worth adopting a similar strategy in order to achieve the best returns from your portfolio? The answer is no if you are hoping to make short-term gains. This year, in the UK, it would hardly have made a difference whatever tack you took. The FTSE All Share index has been almost flat since the beginning of May.

And if you adopted this tack last year by selling equities at the start of the summer you would have missed out on a bumper 9 per cent gain over the same months, amid the sharp stock market recovery in the wake of the Iraq war.

Over the long term however, there is definite evidence that the theory works well. Richard Batty, global investment strategist at Standard Life Investments, says there appears to have been abnormal profit in the very long run from a market timing strategy that moves between equities and cash at set times during the calendar year.

Equities appear to earn most of their returns during certain months, typically either side of the turn of the year. Some put this down to portfolio re-balancing ahead of the tax year-end in April. Profits tend to be strongest in the fourth quarter of the calendar year in the lead up to Christmas, and City analysts are at their most positive in the New Year. This typically can coincide with strong dividend payments from the previous quarter, Mr Batty says.

He says investors who held the US equity market (ignoring dividends) in the six best months of the average year and remained in cash for the rest of the time, would have achieved a 3.5 per cent annual outperformance against the benchmark since 1965.

If investors followed the UK's "sell in May" rule for the US market they would have achieved outperformance of 3.1 per cent in each year since 1965. The cost of trading will, however, depress that outperformance. Assuming each move into and out of an equity market costs 1 per cent in transaction fees, this cuts the annual outperformance from the "six best months" strategy to 1.5 per cent. Two transactions a year for the St Leger strategy reduces annual outpeformance to 1.1 per cent. Clearly, the size of the transaction cost is very important in determining the level of profit.

Financial advisers warn that trying to time the market is a risky business. Darius McDermott, an independent financial adviser at Chelsea Financial Services, comments: "If the market was purely dependent on cyclical economic changes, then markets would be fairly easy to call. However, the world does not work as we would like it to, and markets are dependent on so many other factors. Terrorism, natural disasters and investor sentiment can all contribute to how markets react, and many such events are impossible to predict."

And David Cowdell, director at Fidelity Investments, says: "There is no historic evidence to support the St Leger Day theory. In addition to pulling out of the market and missing potential uplifts, investors would also have to pay extra charges to buy their way back into investment funds each year."

An analysis of returns over the past three decades by Fidelity shows that savers could have forfeit as much as a quarter of their investment growth over 25 years if they had regularly pulled out of the stock market in May, and then returned in September. If someone invested £7,000 in the FTSE 100 index in January 1978, their investment would now been worth £69,646, equivalent to an annual return of nine per cent.

Had the same investor sold on 1 May each year and returned on 11 September, their investment would be worth £53,604, equivalent to an annual return of 8 per cent, a difference would be £16,042.

Justin Modray, a financial adviser at Best Invest, based in London, says the investing rule of thumb suggests that being invested in the market long term is more important than holding off investing until you think the market is at a low. "The reason for this is that the highest stock market gains tend to be concentrated in a short period of time. By the time you try to jump on the bandwagon you may well have missed it," he says.

Graham Spooner, a stockbroker at the Share Centre in Buckinghamshire, says: "While there is an obvious case for being out of the market when things are sleepy, we would not recommend this. However, sometimes there is a case, at the margin, to switch the portfolio into more defensive areas like utilities over these months, but that also depends on the specific market conditions at the time."

But while letting the calendar dictate your investment may be quite a gamble, there is a clear argument for getting back into equities now. Tim Cockerill, head of research at Rowan in Bath, says after a torrid time on stock markets, things are as bad as they are going to get. Therefore, there is more scope for equities to rise rather than fall.

Indeed, the stock market has been anticipating bad news for some time, and is focused on rising interest rates in the US and at home. The high oil price has heightened the risk of inflation and the threat of further terrorist attacks is ever present. The global economy is slowing after the strength demonstrated last year, and the US Presidential election has added to uncertainty.

"We must now ask ourselves whether there is any more bad news for the market to take on board," says Mr Cockerill. "I can't think of any more bad news that may arise, and I actually believe investors will start to focus on the fundamentals of companies in the near future. When this happens, they will see that there are companies that have been putting in some very good earnings numbers, but have been ignored as investor focus has been at the macro level."

Mr Cockerill says that whilst the stock market isn't about to take off, the main risk now is being out of the market and missing out on potential gains. Mr McDermott says you can remove the risk of investing at the wrong time by making monthly savings with a long-term view.

Investing on a monthly basis enables you to take advantage of current low valuations and reduce risk. This is known as "pound-cost averaging", which means that as the market drops your cash has not lost its value and you can purchase more units in the fund at a reduced price.

"This is a good approach to take to investing in equities over the long term. It may mean weathering a few storms but enjoying several crests of waves. It is the way to best limit losses and maximise gains," Mr McDermott says.

SIX POTENTIAL FLYERS

ROLLS-ROYCE

Mr Holden says this is a stock that has been unloved by the market but is now emerging from a long period of underperformance. "The company is geared into the recovery of global air travel and is sustainably generating cash for the first time in years. The company produced very encouraging first-half earnings, and further upgrades to future forecasts are expected," he says.

CAIRN ENERGY

Mark Holden, manager of the Threadneedle UK Limited Issue fund says despite going from strength to strength he believes this high-flying oil company still has potential for further growth. "Significant opportunities for further exploration in Rajasthan, India, will incrementally add to the company's net asset value, driving the share price considerably higher. So far, Cairn has drilled 22 test wells and hit oil in 10. Between now and May next year they plan to drill between 3 and 5 further wells a month. If the hit rate is anywhere near similar, the shares should enjoy more strong momentum. We are particularly encouraged by significant director buying in recent months."

ICI

Neil Cumming, a senior portfolio manager at Hichens Investment Management, says since Martin Lamb was promoted to chief executive of this engineering group in 2001, he has driven a renaissance in the company's fortunes. He says: "The company has sold various non-core activities and recycled the proceeds, and more, into strengthening their core activities, whilst generating cash in order to reduce group debt. There is scope for further margin improvement and bolt-on acquisitions, whilst using free cash flow to grow the dividend and buy back shares."

MICHAEL PAGE

This recruitment company has already strongly benefited from an upturn in corporate confidence, Mr Fowler says. This has led to a hiring spree not only in the City, but also in the accountancy area in the UK in particular. He says: "With an ongoing tight supply/demand situation in many UK white collar areas, the company is well placed to benefit from further increases in hiring activity and as salaries rise in response, Michael Page's fees should rise as well. Meanwhile, any recovery from its Continental European businesses is barely reflected in the share price, and the company has only just started its US business, which has the potential to increase revenues and profits significantly."

INTERCONTINENTAL HOTELS

The company is enjoying a strong recovery in hotel demand, particularly in the US, says Stuart Fowler, head of UK Equities at Axa Investment Management. It is also benefiting from ongoing financial restructuring, whereby the company sells the majority of its property assets, whilst retaining management contracts and returning substantial sums of cash to shareholders. He expects this should lead to a share price boost in the near future. The company's brand names include Holiday Inn and Crowne Plaza, in addition to its upmarket Intercontinental chain.

FORTH PORTS

The company is based on its original port operations in Scotland but also operates at Tilbury in Essex, where it is increasing capacity. Mr Cumming says: "The secular trend towards the expansion in global trade, and the UK's south east economic bias, favour the company's newer activities and initiatives at Tilbury. There are also substantial opportunities within the property portfolio, especially on the Edinburgh waterfront. Here plans are being progressed to develop over 250 acres of land for residential and commercial use," he says.