Sell in May
But Don’t go away as it is an opportunity.
In a foreshortened week in much of the world, we saw the US tighten oil sanctions on Iran, generally good earnings reports, and equities, oil and the dollar make new 2019 highs, and NDX new all-time highs.
As the debate, heat and emotion of this market intensifies it is perhaps appropriate to interrupt our series on ‘emotional trading’ to anticipate the usual explosion of “Sell in May and Go away” references that will add to the mix. Our response is the same as for the last two years. “You might get away with selling in May but don’t go away or you might miss the round trip.” In other words, May weakness would prove temporary and yield to a new high blowout. Today’s news letter explains the Sell in May phenomenon, and then seeks to apply the small explosion of the myth to the current market.
The context for 2019 (and the clearest index view - a full retest of the Russell (still 9.5% away) all time high), remains centred on three factors: consumer sentiment as reflected by the Michigan Consumer Survey Index, the consequent individual stock earnings, and a sentiment that may appear bullish but remains distrusting and not as invested as it could be. Understanding the interaction of these three elements has been and will remain key to stock markets in 2019 and is why it will be the separate subject of next week’s newsletter. It will also help explain why a sentiment driven move will potentially ignore the underlying fundamentals and yields and eventually still prompt USD weakness. 2019 stock markets will remain a predominantly sentiment driven market where traders will look increasingly for excuses to buy rather than the underlying fundamentals that prompt the eventual sell off. Sell in May could well be one such excuse. It is therefore useful to understand the origins and relevance or otherwise of this market aphorism.
Mark Twain summed it when he said "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February." Each and every month can and has been associated with rallies and declines. But they are prompted by a particular cause in a particular phase of the cycle. We often use averages that can produce conclusions such as ‘sell in may’ but they gloss over some of nuances and in particular, other influences that may be driving the market more. In a sense if you use averages, you get average results. But you can take the average to the superior by factoring in the prevailing conditions.
At Matrix we believe strongly in evidencing all our analysis and trades. The weight of evidence suggests some countries, instruments or sectors can underperform in the May-October period compared to the rest of the year but not always. It is the particular position of the markets now within an historic Trumpflationary bubble that particularly skews this year’s Sell in May as it has done since 2016.
The phenomenon of falling stocks in the May-September period can be traced back to the UK as early as 1694 when money would flow out of equities into fixed-income loans to farmers to pay summer labour. When the harvest was gathered and sold, the money would flow back into equities. There is therefore an historic grain of truth to the Sell in May.
The earliest known direct reference to Sell in May aphorism is also British:
Sell in May
And go away
Come back on St Leger’s Day
The St. Leger Stakes is the last horse race in a society season that evolved in 17th century Britain and now starts with the 2000 Guineas in early May and comprises such events as the Chelsea Flower Show, the Derby, Henley Regatta and Cowes Week. These events were well attended by stockbrokers and investors who were almost exclusively drawn from the aristocracy. As they did not have access to live market information or dealing they would sell their stocks and go to cash for the summer.
The self-fulfilling nature of this ‘Sell in May’ social phenomenon could still conceptually apply as Northern Hemisphere vacations do account for generally lower volumes, lower volatility and therefore technical pullbacks. But they would theoretically also limit the downside. In a financial world where the Southern Hemisphere is increasingly important, whose access to prices is instant, whose time horizons are much shorter and driven as much by non-seasonal events, the reasons for depressed stocks in the summer months have clearly declined.
The evidence is clear. US markets on average perform less well in the 5-6 months from May than they do the rest of the year. This underperformance is more noticeable outside of the US. But that doesn’t mean they go down or that the price movement in the northern hemisphere summer is either consistent or uniform. It varies considerably depending on where the market is within both the economic/political cycle and the overall trend.
May-October Relative US Under-Performance:
Over the last 20 years, the average move upwards in the SPX has been 8.7% in the winter half of the year and 2.8% in the summer half. The DJIA is even more pronounced. According to the Stock Trader's Almanac, the Dow Jones Industrial Average has had an average gain of 7.5% during the November through April period and a gain of only 0.3% over the May through October period, going back to 1950.
Global Under-Performance: Bouman and Jacobsen also found that the effect applied in just about every market, as shown in this chart by Jun Wei Yeo, even in Australia, where May to October is of course the winter period.
This under performance is stronger in the original source of the Sell in May phenomenon, the UK and highlights an important nuance. The sell off, if any, is most noticeable at the start of the period and may be due more to a short-lived self-fulfilling sentiment than any longer lasting fundamental cause.
On average there is a 3% decline in the first two months, which then fully recovers, and fades about 2% into mid-September. The UK Stock Almanac points out that May and September are statistically the worst months in the market.
The German DAX also followed this pattern of an early decline during the bull market of the 1980s but has since shifted to a stronger August sell off.
Seasonality within Seasonality:
A cursory glance at SPX performance between May and October 31st for the last 90 years and, separately, the more pronounced uptrends such as we have experienced since 2009 reveals a clear pattern. Lacklustre range trading from May to mid, even late June (net -1% on average) is then followed by a rally in August-September that frequently exceeds the scale of the initial range (net +4% average).
But these are averages and, by definition, ignore cyclicality and the context of the overall trend. More specifically the chart below highlights the period May 1 to Sep 30 for the last ten years, mainly in uptrend. Only six showed negative returns for the first four weeks (May itself), but in eight of ten, a sharp pullback occurred after six weeks. Only in 2007 and 2014 did the market carry on rallying until late July. In the three years from 2010, the market literally sold off on May 1st.
This highlights the importance of specific conditions prevailing at the time and the underlying trend. The average May performance during the 1920s and 1980s bull market is not particularly impressive but nor is it particularly bad.
But it is also important where the market is within that trend. Clearly, we think it is in the latter stages and, we also suspect, it is slightly in advance of the 1929 and 1987 seasonality.
The reasons for the Sell in May phenomenon are historical and now largely seem outdated. Although markets do underperform for the 6 months after May compared to the rest of the year, we suspect causality may be more self-fulfilling than anything else. Any sell off in May will invoke the aphorism and encourage sellers that will help fuel the later blow out. Next week we will explain why and how Sell in May is better seen as an opportunity.
Here’s to making the very best.
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