Hi Guys,
Annually we revisit the aging Wall Street adage to “Sell in May, and Go Away”. MFO contributor Skeeter posted on this topic in early May. There is ample historical data to support this proposition. It is all grounded in statistical data sets. The statistics are its basic strength, but also its inherent weakness.
Every May, we are persistently exposed to the fundamental data, both in the business media and here at MFO. Here is one sample media article that takes exception to the invented Sell in May guideline:
http://www.businessinsider.com/no-dont-sell-in-may-and-go-away-2013-5The referenced article presents a 50-year data gathering effort. The study timeframe is an important parameter selected by the research team. To a large degree, it influences the specific findings, and in some less frequent instances, it establishes an outdated trend-line.
Unlike a mechanical system that has a reasonably understood and predictable lifecycle history, the historical database of a system, that is dominated by human decision making, by complex interactions, and by its perceived persistency, is highly suspect. A meaningful tradeoff exists between accumulating a statistically self-consistent data set and the degrading freshness of that same data. The financial marketplace is a dynamic entity influenced by both unpredictable endogenous and especially exogenous events like totally unforeseeable Black Swans.
For many investment studies, the bottom-line is that if the data collection period were modified, the findings would be changed.
But more significant for the purposes of this posting is the interpretation and the exploitation that this evolving calendar data permits. The exploitation is tightly coupled to the current economic, political, and financial environments, and the relative attractiveness of alternate investment options, like cash for instance.
It all depends on the potential payoff and risk matrices for the available alternate investment opportunities. I’ve assembled and now document a few tradeoff considerations from a variety of sources. The goal is to make more informed decisions and to accrue better returns during the typical mid-year equity doldrums.
First, let’s establish a target baseline. These data come from John Buckingham’s “Prudent Speculator” May newsletter. In rough terms, the October-April period has generated a 8.2 % partial annual return; the May-September period has added a more meager 2.3 % partial annual return to enhance the anticipated payoff to a 10.5 % annual long-term record. Given the very thin mid-year returns, a more diligent monitoring of overall composite environment (political, economic, international, financial) is mandatory in the summer time to protect our portfolios.
Second, given that the easily accessible alternate portfolio options of cash and short-term bonds are yielding below inflation rate returns, all other factors being equal and unchanged, staying invested in the equity markets is an obvious choice. The prospects for a 2 %-plus return for the quite period is a no-brainer over a likely 0.1 to 0.5 % return during that same timeframe from fixed income sources.
Third, various research findings have provided guidance for strategies to improve the expected equity baseline returns. For example, the pioneering Fama-French studies suggest that a portfolio with a value and particularly with a small-value orientation could augment the baseline rate of return by perhaps a 2 % increment. Buckingham’s studies, with a fresher set of data, reinforce the earlier work. His research also concludes that a portfolio constructed with the highest one-third of dividend paying stocks could outperform a non-dividend portfolio by another 2 %. Of course, these potential pluses are bounding numbers since a typical portfolio really should contain a more balanced mix of holdings.
Fourth, recent momentum studies suggest that a positive momentum early in a year, continues through the summer doldrums. Momentum persists in the short term (months). The likelihood that the equity markets will produce returns in excess of the historical record approaches the 80 % range (I lost the specific reference to that figure). Tilting the odds in your favor is always a good thing. Here is a Link to one optimistic assessment that illustrates the disparity in summer equity returns when cash has an attractive return and when it does not compete with even subdued equity rewards:
http://www.bellinvest.com/resource-center/publications/Sell-In-May-And-Go-AwayFifth, the old saw that the market doldrums reflects the fact that the major market participants are vacationing is no longer valid. Two distinct factors have altered that interpretation. The market trading is now controlled by institutional agencies. Individual investors were 70 % of the trading volume two decades ago; today, 70 % of that activity is generated by the gigantic professional units. These agents never go on a holiday. Also, even when a trader is vacationing or away from his office, the modern computer and communication tools permit, in fact encourage, trading from anywhere and at all times. Traders never rest.
Sixth, a plethora of academic and industry generic studies have demonstrated that both a passively managed investment portfolio and attention to low cost investment control improve expected returns. This is especially applicable when operating in an anticipated low return environment. Any incremental cost drag pulls the net return downward a disproportionate percentage.
Because of these factors, and likely many others that escape me, it is my opinion that the “ Sell in May, and Go Away” axiom is not currently functional in our present marketplace. At least for now (things change), it belongs in the dustbin of history. Both strategic and tactical investment policies depend on circumstance, technology, and changing demographics. Nothing is invariable; stability in the marketplace seems to be an oxymoron.
Since my portfolio already reflects most of the elements I discussed, I’m simply standing firm. I will definitely not sell in May and not go away.
Please comment and share your opinions.
Best Regards.
Comments
Unless the economy rolls over or quantitative easing ends, stocks could keep rising."
This commentary below makes sense to me. So this is reason 6.
https://www.fidelity.com/viewpoints/market-and-economic-insights/timmer-may13-commentary?ccsource=email_monthly
There are some elements in the market that concern me while corporate earnings are being reported with many companies exceeding expectations. This is due in part to revisions that analyst make prior to companies reporting and in many cases just days before. Some predicted that forward full year earning for the S&P 500 Index would come in somewhere around the $115.50 range towards the closing days of 2012. Current revisions, by some, now have this number in the $113.25 range. This is a reduction, thus far, of not quite two percent; however, should the revision reductions continue at the current pace for the rest of the year then this brings full year anticipated earnings to about $109.00 (high side guess) per share on the Index.
Taking the recent high for the Index at about 1675 this equates to an estimated P/E Ratio of about 15.3 which falls at about the mid point of what is said to be a normal range for the Index at about (14 to 16). But, there again, projected earnings must materialize for this to become fact.
Now that is my perceived earnings picture; but, there is more to the story and that is the revenue picture. It seems that companies are having a more and more difficult time in growing their revenue landscape and without revenue growth then there is really no growth from my thinking. And, this is where we are at today from my thoughts. So if stocks sell more going forward, without revenue growth, it will be because of what is know as P/E expansion. With this, investors become willing to pay more and more for earnings … but, not me.
Another thing that concerns me is that there may be a change coming within the FOMC itself with a new Fed Chair. This in itself creates a lot of uncertainty by my thinking and is not good for the markets.
Going back to my college days and using a fair value analysis formula, that Professor Sturgis taught in his class which is a quick and down and dirty means to compute fair value, I compute that the S&P 500 Index has a current fair value of about 1455. This takes into account the stale revenue growth that now prevails along with a projected earnings outlook. Using this method puts the Index in overbought territory by better than ten percent. Even Morninstar’s Market Valuation Graph currently has stocks overvalued in general by about three to five percent and some of the sectors by as much as 15%. So there is some thinking not only by myself but others too that stocks are now overvalued.
For me it was a no brainer to reduce my allocation to equities once I began to detect that they were becoming overbought and as we move into the summer months which are a traditional slow period for stocks I positioned accordingly. Those that have followed my past post know I have been a seller of equities since the first of the year through utilizing a systematic sell process as equity valuations advanced and were becoming overbought by my thinking.
Currently, I have positioned my asset allocation for equities towards their low range at about 40%. A high range equity allocation for me would be around 60%. When I start to discover that there is more value in equities then I will again ramp up my equity allocation … but, until then … I am on vacation.
I hope you enjoy your summer … and, most of all … I wish you ... Good Investing.
Skeeter
Hi Skeeter,
Thank you for contributing your personal forecast for the near-term equity markets. It is logically, persuasively and cogently stated. It is based on current and historical economic and political watershed markers. Your integration of the various input parameters is fundamentally solid and commands immediate respect.
I’m sure all MFO participants will benefit from your present analysis and perspectives, even those who would take issue with your temporal short-term judgment. We all recognize that the marketplace is in a constant whirlwind of competing forces, none of which are totally predictable. We look forward to any directional wind shifts that you perceive might develop in the next few months that will modify your assessments.
I like your methods and your documentation of it. Thanks for your kind words with respect to my writing style. That’s great, but I really try for substance over style. At my age, the style part was added in an attempt to keep a sharp mind. I equate it to my doing a Sudoku each and every day. It’s part of my daily mental exercise program. In no way does your writing style and substance matter take a rear seat to my efforts. Your documentation is organized, researched, informative, and fun.
Keep in mind that “my” forecast was for the remainder of the year. I purposely placed quotation marks around “my” forecast because in reality, I do not make creditable annual market forecasts for two generic reasons.
First, I do not have the skill set nor the necessary data sets, nor do I commit the needed time to generate a respectable forecast.
Second, and most importantly, I do not credit these forecasts with any high level of precision. Simply put, I do not trust them, but they are fun anyway.
I do make very minor adjustments to my portfolio’s asset allocation holdings based on these imprecise projections. Investment decisions always include some elements of a gamble.
Like you, I prefer to maintain my asset allocation in the 40 % to 60 % equity range. I am never totally into equities; I am never totally out of equities. That overarching policy reflects my mistrust of any reliable forecasting acumen. Just too many unknowns and imperfect modeling.
For the record, my current portfolio is about 48 % equities. That’s up a little YTD because of the favorable market rewards so far.
My judgment to not adjust my present equity holdings in this posting is based on my informal assemblage of the numerous opinions, both positive and negative, expressed by the professional money managers at the Las Vegas convention. My opinion is an amalgam of their analysis and assessments. In a very loose sense, that decision reflects sort of my personal Kalman filter mental application to the forecast exposures at those sessions. I did give extra weighting to those forecasters who I perceived had a better predicting record. History matters.
Besides, historically the equity market delivers positive annual returns about 70 % of the time, so I’m on the more likely side of the odds. That’s almost always a good position.
Once again, thanks for your probative analysis. It and its documentation are equally excellent. A diversity of opinion is eternally welcomed.
Best Wishes.