There is nothing like a seasonal pattern to rankle analysts, unsettle investors and get behavioural finance experts foaming at the mouth. Investors have various levels of expectation about the influence that events such as Santa rallies, presidential election years and tax calendar effects may have on stocks, and at least some of it appears to be warranted. Indeed, the mere anticipation of these occasions is claimed by some to be self-fulfilling; if investors expect stocks to fall then that confidence often means they will, come what may.
But what about the big one? Given that the phrase “Sell in May and go away; don’t come back till St Leger’s Day” is probably the best known of the seasonal trading strategies and that another strong rally through the winter months has started to tail off, we thought it wise to investigate whether investors should pay it any heed. Certainly getting out in May last year, shortly before the market crashed, could have saved investors a tidy sum. So what are the odds for this year, and should you get out early?
Why anyone cares about selling in May
Seasonal patterns have an almost magnetic attraction for academics, which means there is no shortage of research on the subject. In 2002 Ben Jacobsen and Cherry Zhang produced a paper that found the Sell in May strategy beat the market more than 80% of the time over five-year horizons and more than 90% of the time for ten-year horizons.
That said, professional money managers and analysts tend to be more sceptical. Last year, Evolution Securities (now Investec) and F&C Investments put out separate research debunking wide seasonal variations in market performance. Meanwhile, a detailed assessment by Fidelity’s Tom Stevenson was slightly warmer to the idea, with his 20-years figures generally showing better returns from investing through the winter. Importantly, Stevenson stressed that the transaction costs of a Sell in May strategy could wipe out any potential gain and he concluded that staying fully invested still looked like “a sensible, and much less stressful, approach”.
So, the professionals think that a Sell in May strategy is generally the wrong course of action and, to be fair, a quick look at recent history offers a mixed picture. If you had sold in May 2009, for instance, you would have missed a major run by the FTSE 100 that returned a 17.9% gain over the summer. In 2010, the market dipped again during the summer but bounced back for October, meaning a wafer thin margin (if any) for traders. But investors ducking out of FTSE 100 on May 3 last year would have taken more or less the last chance to exit at just north of 6,000 points. Three months later the FTSE 100 had lost 1,000 points as investors took flight.
The markets may have rallied enough
The market’s performance during the first quarter of 2012 was so similar to 2011 that analysts have begun weighing the odds of confidence once again withering by mid-year. Schroders recently issued a note claiming that there are some key differences that should offer more protection this year. In particular, oil prices had not risen as rapidly and food prices were down, while Europe’s policymakers had, before the recent Spain issues, looked like they were getting a grip on the sovereign debt problems that are proving so troublesome. Meanwhile, low interest rates and the stimulating effects of quantitative easing – or money printing by US and European central banks – have been a boon for equities.
All this contributed to a great start to 2012 for the FTSE 100, which rose by 7% in the first 11 weeks of the year. In the US, the S&P 500 had been rallying since last October albeit with frankly massive support from technology giant Apple. On that point, Jonathan Golub, a US equity strategist for UBS, recently predicted that the S&P 500’s first quarter earnings were on track to rise 6.8% with Apple, but would be a more modest 2.8% without the world’s most valuable company.
Could markets be set to correct more strongly?
Doug Kass, an investment commentator and president of US hedge fund Seabreeze, recently listed a series of reasons why he believed the S&P had peaked – as opposed to his peers, many of whom are committed to chasing the index’s eye-watering momentum. In particular, he thinks the macro environment in the US could soon weaken as a result of slowing growth, political gridlock post-election (Obama remains president, with a Republican Congress) and the prospect of a “natural price discovery” in markets if a third round of QE isn’t forthcoming. Kass is unequivocal in his position: “Why wait until May when you can sell today?”
Kass also acknowledges that the same, possibly worse, scenario exists in Europe, where sovereign debt issues and the risk of contagion are among the main causes for concern. Bill McNamara, a technical analyst at broker Charles Stanley Securities, says that the recent declines in the FTSE 100 have very clear reasons: “US growth might prove to be less robust than previously anticipated, while the rise in Spanish bond yields demonstrates that we are still a long way from a situation where all is well in euro-land.” He believes that further turbulence remains possible, while a drop below current levels would imply that the entire rally since October was being corrected.
So, while stocks may have performed spritely in the first quarter of the year, macro influences still risk causing significant damage. With the crutch of financial stimulus not so certain, a weak economic recovery and the prospect of further shocks in the eurozone (with Spain looking a real concern), stocks just don’t look safe. When the market corrected in 2011, the trigger was a combination of US politicians dragging their heels on raising the country’s debt ceiling and increasingly bad news on the state of Greece. Betting against similar factors denting confidence again this year would be brave, lending weight to the idea that a Sell in May strategy will prosper.