Sell in May and Go Away? Not Always…

Eric Fry By Eric Fry
Macro Strategist

Market Trends

“Sell in May and go away” did not become a Wall Street truism by accident… or just because it rhymed.

The saying emerged from the fact that stocks tend to perform poorly from May through September, at least relative to the October through April stretch. It’s backed by decades of proof.

According to Jeffrey Hirsch, author of Stock Trader’s Almanac, the U.S. stock market tends to produce all of its gains in the six-month period between November 1 and April 30. Thus, a hypothetical investor who placed $10,000 in the Dow Jones Industrial Average at the beginning of May each year since 1950 and sold at the end of October would have made no money whatsoever. Nada.

On the other hand, the investor who purchased the Dow Jones Industrial Average at the beginning of November each year since 1950 and sold out at the end of April would have turned $10,000 into more than $850,000!

Clearly, summer tends to be more like “bummer” for the stock market. And this seasonal tendency is not the only reason for caution this year.

Two additional indicators are sending ominous signals.

First, the midterm election cycle is hanging over the market like a guillotine. Data from Standard & Poor’s shows that in a president’s four-year term, the second and third quarters before midterm elections are the weakest periods for stocks. The S&P 500 has fallen, on average, 2% and 2.2%, respectively, in those quarters since 1945.

“Midterm election years have been the second worst year of the four-year cycle,” Stock Trader’s Almanac points out. “In the last 14 midterm election years, bear markets began or were in progress nine times.”

A dismal stock market performance prior to this year’s midterm elections would not be difficult to imagine given the high anxiety and uncertainty surrounding which party will emerge from the midterm election with control of the Senate and/or House of Representatives.

A second indicator also suggests that stocks will be heading lower. In four of the six instances since 1970 when a new central bank chairperson took the helm, stocks slumped over the ensuing 12 months… sometimes sharply.

The Black Monday crash of October 19, 1987, took place two months after Alan Greenspan became chairman of the Federal Reserve Board of Governors. Ben Bernanke was one of the two Fed chairs who managed to avoid the “year one curse.” But his third year was 2008, which was a doozy!

Three months ago, Jerome Powell succeeded Janet Yellen as Fed chairman, which means that the stock market is likely to go through a rough patch over the next few months.

Stocks have already fallen 4% during Powell’s tenure. And additional stock market weakness is certainly a greater-than-zero possibility given that Powell intends to continue hiking short-term interest rates.

Historically, the stock market despises rising interest rates. Already, interest rates along the entire yield curve are hitting multiyear highs. The five-year Treasury yield, for example, is currently 2.82%, which is the highest level since 2010!

To be sure, the promising confluence of these negative seasonal factors does not guarantee a sell-off in the stock market. But it does provide ample reason to “sell in May,” especially in the context of record-high stock valuations.

According to economist Robert Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio, the S&P 500 Index is trading at its second-highest valuation since 1871.

This extreme reading puts its valuation in the 97th percentile of all readings from the last 137 years. In other words, the stock market has been more expensive than today’s reading only 3% of the time – and it has been cheaper 97% of the time!

That’s a very high valuation…

In the stock market, buying high sometimes produces profits, but buying low is usually a better bet… especially when the calendar flips from April to May.

To borrow from the 1960s rock band The Byrds (who borrowed from the book of Ecclesiastes), “To everything there is a season.”

Based on historical precedent, the season for loading up on stocks ends in May.

But don’t panic. Lots of individual stocks somehow figure out a way to swim upstream – just like spawning salmon. In the natural resources sector, in particular, many stocks are moving higher, even as the overall stock market flows downstream.

Over the months ahead, I expect many resource stocks to maintain their upward course.

Good investing,

Eric