Should you sell in May?

It seems odd. Just think of how the economic debate in Australia has changed. Late last year, and early this year, it was the end of the world. The mining boom was finished and the country was headed into a downturn. Now, even the Reserve Bank is talking of stronger-than-expected growth and the media, having just finished talking about the mining bust, is now obsessed with the ‘property boom’ and, more to the point, a supposed imminent bust.

Meanwhile, the Australian stockmarket has done little since October, which is bizarre given the paradigm shift in the economic debate. Instead we have had the weakest equity performance for an October to April period since the global financial crisis (with the All Ordinaries experiencing flat to negative growth).

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Ordinarily this period is one of robust capital gains. The average gain since the mid 90s is about 5-6% and, in fact, the market has only posted negative returns on four occasions since then. Two of these were in and around the GFC. So it is unusual.

So what’ going on?

Unfortunately there isn’t a lot of information we can garner looking at the sectoral split. And, of most importance to our market, the big banks and miners (41% of the All Ords) aren’t showing any clear sign – they are either flat or down about 1% or so. Just like everything else. That doesn’t mean there is a shortage of structural explanations and an army of pundits who’ll tell you what they believe is wrong:

• The market is expensive, there is no value.
• The Chinese economy is slowing and this will weigh on Australian growth and equities.
• The Fed’s taper.

Yet each is inadequate, by itself, as an explanation. I’ve dealt with these issues before but, as a brief reminder, there is little to say that the market as a whole is expensive. Key price-earnings indicators, ultra-low rates and an economic rebound suggest there is ample scope for further price gains. More to the point, where else can an investor go? Bonds are even more expensive, as are cash products, and both perform more poorly on a yield basis. Property looks great, sure, but no-one is going to have a 100% allocation in just one sector.

As for China, the concerns of a slowdown are never ending. They have been with us for a decade and always come to nothing. That’s not to say that China won’t have a more serious slowdown one day, but an investor can’t take the incessant talk seriously or factor it in to their investment decision. When it comes to China, there is no rational discussion. Finally, the Fed’s taper was first flagged in May last year and we certainly saw markets sell off in response. Since then, however, global markets have risen strongly. In fact, since the first Fed taper in mid-December the S&P500 is up by more than 5%. So I think the market has taken US monetary policy in its stride.

The truth is, I don’t see any real fundamental reason why our market has been in a lull. With no structural headwinds to deal with, I think the most likely cause for the market rut is simply timing – or rather unfortunate timing. Clearly the market and, in particular, international investors accept that the consensus view on the Australian economy that had dominated sentiment up until recently was wrong. That is that Australia was headed into a downturn and growth would be weak.

Most people accept that now – the RBA certainly does – and we are seeing this confidence manifest in a stronger Australian dollar. It is up 6 cents or so since the low reached at the end of January. Normally we see a close positive correlation between the $A and the All Ords. When one goes up so does the other, and this makes sense, although as yet stocks have not moved as such.

The problem is that at the same time investors were reassessing Australia’s prospects the US was hit with bad weather and, of course, there was the Crimean crisis. I don’t think this market lull is any more insidious than that.

Sell in May…

This is where timing could become even more unfortunate. We are coming up to the well-known May seasonal period. The old sharemarket saying is “Sell in May and go away”, in reference to the apparent tendency for equity markets to weaken in the May to October period. Unfortunately the statistics don’t look great:

1. Since 1995 markets have sold off from May (or thereabouts). Sometimes it’s earlier and by more than just a few per cent. This has happened in 13 of the last 19 years, so 68% of the time. A sell-down has occurred in each of the last four years since the GFC, with an average peak to trough fall of more than 14%. If we get that again this year, it’s quite possible we won’t be seeing much in the way of capital gains at all for the year and I can appreciate why many investors may be thinking of investment alternatives – even cash!
2. Markets do rebound though – normally from July – yet even with that, the average May to December period (from the may peak to December 31) since 1995 is only about 0.6% where the May seasonal has taken effect. Within that, when the May seasonal does take effect, the market ends the year below the May peak nearly half the time (46%).

It doesn’t look good. I’m the first to admit that while returns to cash are rubbish, they are still better than nothing. There are a few things to note though. Firstly, a 68% chance (of the May seasonal kicking in) is far from a guarantee. Moreover, on the 54% of occasions when the market ends higher than the May peak, the average gain is about 5-6%. Not bad, and still better than cash. Perhaps more importantly, in most of those cases where the seasonality did occur, it didn’t just happen. There was a clear and identifiable catalyst for the turn in sentiment.

For instance, in the early 2000s we saw a recession in the US (and a downturn here), the bursting of the dot.com bubble and the September 11 terror attacks. In 2006, central banks around the world had either recently started or ramped up the tightening cycle. We saw that again in 2008 before the GFC, and then over the last four years we’ve seen a combination of the European debt crisis, talk of Chinese hard landings and US double dips or fiscal cliffs. That's especially the case when the market ended the year lower than the May peak. There was always something big behind it.

Will May heat up?

This year there doesn’t appear, as yet, to be any catalyst or reason to see a significant sell-off from May. Could it be Crimea? Maybe, though that’s unlikely at this point. Could it be China? Same conclusion as above. It would take something new – more than just a slowing I think – some crisis. In the absence of that is it quite plausible that our market will lift during the usual May seasonal. It’s happened before . In 2004, for instance, the market lifted 3% or so over that period before rallying hard in the latter part of the year (16%).

With that in mind, I don’t think investors need to beware the ides of May at this point. I’m not dismissive of it, as it is a very strong seasonal. But I wouldn’t pre-empt it at this point or be making any significant portfolio changes in anticipation of it.

More likely, the market will rally. But what will it take to get that rally? Not much. Firstly, watch for the economic rebounds in some US figures. That weather distortion will wash out, and if it does data may surprise on the upside. Consequently, any hint of value that creeps in will be jumped upon. Again, another reason why I don’t think we will see a meaningful May seasonality this year.