The media remains fascinated with the expression "sell in May and go away." Media expectations are that North American equity markets will move lower from the beginning of May to the end of October.
Their fascination has been triggered by weakness in North American equity markets from May to July during the past three years. From its peak in late April to its low in July, the S&P 500 fell 17.1 per cent in 2010, 19.7 per cent in 2011 and 8.9 per cent in 2012. During the same periods, the TSX composite dropped 20.2 per cent in 2010, 19.1 per cent in 2011 and 7.7 per cent in 2012. The media are asking "Why have North American indexes not dropped this May?"
The answer requires an explanation about why equity markets move higher on average from November to May and in an irregular pattern from May to November. Thackray's 2013 Investor's Guide notes that more than all of the gains by the S&P 500 index during the past 62 years and the TSX composite index during the past 36 years have been recorded from October 28 to May 5. The favourable period coincides with a series of annual recurring events that trigger investor buying in equity securities. Events during the period include improving seasonal economic data, the end of tax loss selling late in the years, the Santa Claus rally at the end of the year, investment of year-end bonuses early in the New Year, contributions into RRSPs to the end of February in Canada, top ups into Tax Free Savings Accounts early in the year in Canada, contributions to 401K plans until mid-April in the U.S. and first quarter earnings reports into April that coincide with upbeat annual meetings.
What happens between May 5 and October 28?
Very little! Annual recurring events that influence equity markets with the exception of second quarter earnings reports are lacking. People go on holidays. Volumes in equity markets are lower than average. Lower volumes lead to greater price spreads for equities and greater price volatility. Equity markets are influenced by non-recurring annual events that investors are unable to anticipate. Ironically, the S&P 500 index from May 5 to October 28 recorded gains in seven of the past nine periods and the TSX composite recorded gains in six of the past nine periods. However, net return was negative because gains were small and losses were huge. Indeed, data from Thackray's book shows that only two periods from October 28 to May 5 have recorded a loss of 10 per cent or more during for the S&P 500 index during the past 62 periods. In contrast, eight periods have recorded a loss of 10 per cent or more from May 6 to October 27. The largest loss was 39.7 per cent recorded in 2008. If a negative event impacting equity markets occurs, it usually happens between May 6 and October 27.
What about this year?
First quarter reports released in April received a mixed response. Most big cap stocks in the U.S. and Canada moved higher in early April, but quickly came under "sell on news" pressure when their earnings were released either in line or below consensus. Exceptions occurred when a company reported "blow-out" earnings and revenues relative to consensus. The biggest difference this year relative to 2010, 2011 and 2012 was the April employment report released on May 3 that recorded a gain in employment not anticipated by the market. Net result was that U.S. equity markets virtually launched into all-time highs. Since May 2, the S&P 500 index has gained 4.5 per cent. Once again, price volatility in equity markets during the May 5 to October 28 period has appeared. However, unlike previous years, volatility at the beginning of the unfavourable season has been expressed with higher prices.
What is the current preferred strategy for equity markets?
Traders generally do not like uncertainty based on unanticipated non-recurring events. The period from May 6 to October 27 is the weaker six month investment period and presents greater equity market risk. Best strategy during a period of higher- than-average risk is to avoid the risk, particularly when North American equity markets are overbought and vulnerable to at least a 5-per-cent to 10-per-cent correction. Possible events this summer, that could trigger an equity market correction, include a reduction in the Federal Reserve's quantitative easing program, additional weakness in the U.S. manufacturing sector, more fiscal unrest related to extension of the U.S. debt ceiling and growing political tensions in the Middle East.
As an alternative to equity markets, positive seasonal opportunities in the summer exist in select sectors including bonds, biotech, consumer staples, agriculture and gold.
Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. Daily reports are available at http://www.timingthemarket.ca/ . He is also a research analyst for Horizons Investment Management Inc. All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management.