Will ‘Sell in May’ be right in 2018?

“Sell in May and go away, come on back on St Leger’s Day”

“Sell in May and go away, come on back on St Leger’s Day”

It’s one of the stock market’s favourite phrases. It goes back to the days when the country’s ‘well-minted’ brigade used to leg it from London as the weather got warmer. And then return to the capital in mid-September at the time of the St Leger Stakes (which is run at Doncaster racecourse).

In short, traders who sell in May want to be out of the market during the summer.

So will that be the right thing to do this year? And is there a stronger reason for getting out of stocks right now?

Deja vu

Yes, I have written about this a few times before.

And in recent years I’ve favoured the Sell case. Which was right in 2008 (Great Financial Crisis), 2011 (Eurozone sovereign debt crisis) and 2015 (Chinese stock market crash). But before I start to congratulate myself too much, I have to admit that my advice has also been wrong a few times.

Like last year, when the FTSE 100 hit a low point around the end of April. Sure, since then stock prices have hardly raced away. But on balance they’re higher than 12 months ago. What’s more, by being out of the market you’d have missed out on some decent dividends as well.

As ever, America’s stock markets are setting the global trends in equities. Watching Wall Street is one of the keys to success for London market players.

Looking at history doesn’t give you a clear guide about selling in May. While over the last 20 years the total return for the S&P 500 – the world’s most watched stock index – between May and October has averaged just 1.2%, according to CNBC, it was higher during 70% of that period. But between November and April the S&P rose 85% of the time and averaged a 6.2% total return.

That said, Ryan Detrick, the senior market strategist at LPL Financial, notes that US mid-term election years – of which this is one – have on average produced lower returns in the May-to-October period than have other years. Against that, Detrick says that the April-to-November periods in those mid-term years have actually generated above-average returns.

Confused?

I was. Then I cast the net wider and looked at longer timeframes. And I felt myself becoming even more befuddled by the range of ‘Sell in May’ stats.
So eventually I threw them all away. But not before noting that this year, almost every commentator to write about selling in May seems to think it’s a bad idea.

As a contrarian investor, I take note of such biases, even if they are anecdotal.

And I examine them to see where they might be wrong.

As you may be aware, this is first-quarter earnings season. Put another way, it’s when companies the world over report on their early-2018 trading.

Indeed, the US earnings season is now more than half completed. And thus far it’s been a good one.

53% of S&P 500 companies have reported results for the year’s first quarter, according to data from FactSet. And 74% of those businesses have produced better than expected sales while 79% have generated a positive earnings surprise. If that trend continues for the rest of the season, it will mark the highest percentage of ‘beats’ since FactSet began tracking the data in 2008.

Meanwhile, earnings growth for S&P 500 companies has been around 23%, which is the highest quarterly rate since the third quarter of 2010.

So at first glance you can see why all those pundits don’t want to Sell in May.

Here’s the problem

The trouble is twofold. First, companies manipulate earnings expectations downwards prior to reporting. Then they beat the lower figure. It’s all a bit of a con.

Second, the ‘don’t Sell in May’ advice doesn’t reflect market levels.

Shares are standing not far off their all-time highs.

In other words, the good news has been ‘discounted’ by stock market indices and is now firmly ‘in the price’. Sure, 2018 looks like being a strong year for US company profits growth. And no doubt that will be echoed by corporate results around the world, including here in the UK.

But what we’re seeing now could well be ‘peak earnings’. There’s mounting evidence that global economic growth is slowing. Both short-run interest rates and longer-term bond yields, again led by the US, are rising.

This is a toxic mix for stocks. They need a constant fix of higher earnings in order to maintain upward momentum. If the opposite happens, down will come prices.

I believe that an equity bubble has formed and that this is a time to be very cautious of stock markets. In particular that applies to the US but it also includes the UK.

If you compare your portfolio’s upside scope with its potential downside risk, at current levels I’m sure you’ll agree there’s much more of the latter. Put another way, at the moment I reckon you need to have very good reasons to hold individual shares. Even then, these are likely to fall back if the mainstream indices retreat.

Dumping shares in May hasn’t always been a great plan. But look at the bigger picture. This year, selling some of them could be a very good idea indeed.

Instead of holding shares…

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