The Big Picture
There is an adage in the market that suggests one should "sell in May and go away." That is borne out in findings by the Stock Trader's Almanac that indicate most of the market's gains through history have been logged from November to April.
You know that other adage that, "if it sounds too good to be true, it probably is?" Well, in this instance, there is truth in the data.
Don't Worry
The Stock Trader's Almanac discovered this switching strategy in 1986 and said it has used it in conjunction with the MACD indicator (moving average convergence/divergence) to help in timing buy and sell decisions for making the portfolio switch.
To maximize return prospects in a given year, one would be fully invested in stocks during the best six months, and to minimize loss prospects, one would be in cash or bonds during the worst six months.
A retroactive application of the strategy revealed a $10,000 investment made in the S&P 500 in 1950 during the worst six months (May-October) resulted in a 74-year loss of $258. Conversely, a $10,000 investment made during the best six months (November-April) resulted in a 73-year gain of $2,473,063.
Not wanting to get that cute in managing your equity portfolio? Don't worry. A simple buy-and-hold strategy with a $10,000 investment made in the S&P 500 in 1950 resulted in an even better 74-year gain of $2,840,172.
To be fair, data from the Stock Trader's Almanac indicates that the switching strategy produced better returns for the Dow (since 1950) than the buy-and-hold strategy, although the latter didn't exactly disappoint in the grand scheme of things either.
Buy-and-hold is a viable, and successful, investment strategy. It may not feel like it at certain times -- and in certain years -- but it has admirably stood the test of time.
We point this out, because there is a lot that goes into an investment decision, which isn't always knowing when to buy and what to buy, but also when to sell and what to sell. There are potentially tax issues, opportunity costs, cyclical and structural risk factors, and the catch-all factor that is... life.
Settle In
We said on April 12 that it would be prudent to shed some risk by taking some profits after the market's huge run from its late-October lows. We clarified that shedding risk isn't same thing as saying sell everything.
The S&P 500, as we write this, is virtually unchanged at 5,122 from its close on April 12 (5,123) when we published that column. It slid to 4,953 on April 19 before rebounding on the back of good earnings news from the usual mega-cap suspects (and some others).
The market has proven resilient, but given the "switching history" noted above, is the move still to sell in May and go away?
The answer is that the answer will depend a lot on one's individual circumstances. Generally speaking, our sense is that one shouldn't go away in May, but instead settle in for what could be a fickle market.
How Much?
The question regarding how much one should pay for every dollar of earnings has become a more pertinent question.
- Do you pay a premium when there is burgeoning economic evidence that indicates the consumer (lower-income consumers in particular), and economic activity are slowing?
- Do you pay a premium with some relative assurance from Fed Chair Powell that the next policy move is unlikely to be a rate hike?
- Do you pay a premium with inflation still adrift from the Fed's 2% target?
- Do you pay a premium in anticipation of the next policy move being a rate cut, which would likely come to pass at a time when economic activity is weakening?
- Do you pay a premium with a huge election cycle in play and the winner of the presidency and the composition of Congress (which will influence key fiscal and trade policies) still to be determined?
These are some of the questions confronting the stock market now after a huge run that stretched valuations. Granted the market's valuation isn't as stretched at 20.2x forward 12-month earnings as it was at the end of March when it traded at 21.0x, but it still isn't cheap at a time of heightened uncertainty. The 10-year average is 17.8x.
The market's valuation is not as stretched because earnings estimates have gone up 1.4% since the end of March while the market has gone down 2.5% amid some more volatile trading action related to alternating views on the economic outlook, the earnings growth outlook, the path for interest rates, the direction of monetary policy, and the geopolitical environment.
That is what happens when a market trades at a full, if not rich, valuation and some cracks in the fundamental view that got the market to where it is start to appear. There is more back and forth action as bulls work to rationalize why the cracks should be fixed and bears work to rationalize why those cracks will turn into breaks.
What It All Means
It is a good thing to see earnings estimates going up. The forward 12-month estimate is $253.86 versus $243.00 at the start of the year and $250.35 at the end of March, according to FactSet.
The question now is, can the earnings estimate trajectory be sustained? It's possible with the might of the mega-cap influencers, but it's also possible that it won't with the influence of a softening consumer.
Like the Fed, the stock market is going to remain data dependent to draw its conclusions. All the market can do now is settle in and wait for the data, trading off each report, and its implication for the economy, earnings, and monetary policy, with a switching strategy that is apt to keep it range bound.
