Wisdom of the ages or a silly superstition? Besides being a catchy rhyme, does it have any basis in reality? Along with the January Effect and the concept that equity markets tend to outperform from October to May, this old market saying returns every year as regularly as Mother’s Day.

While every year is slightly different and most of the studies on calendar variations of market performance conclude that the anomalies are too small to make consistent profits, there is good reason to pause this May and decide what we want to watch for in the coming months. As regular readers will notice, we have our doubts about how well the efficient market hypothesis explains market movements. Those doubts are based on observations of how investors’ emotions can have a significant impact on the direction of money flows and asset prices. That doesn’t mean we are ready to embrace every market superstition but let’s look at some of the reasons why Sell in May might hold some validity.

  1. Earnings Cycle
    By the end of May, most corporates will have reported first quarter earnings. Generally 1Q earnings closely follow the release of the previous years’ fully audited earnings report. March, April and May are very busy periods for analysts. And this year is no exception as they scramble to upgrade their earnings estimates to current trend. The next significant set of earnings won’t come until August/September and the second quarter is a great quarter for booking bad news. So the start of our Sell in May period is a relative data vacuum followed by potentially disappointing 2Q earnings as the summer drags on.
  2. Summer in the Northern Hemisphere
    The saying originally came from England as London stockbrokers and fund managers prepared for the English summer (horse racing, Wimbledon, summer holidays). Market volumes traditionally fall off in summer months and lower liquidity often brings lower stock prices.

So, mark your calendar to take some time this month to review your portfolio. Equity markets have run hard and while equity analysts are falling over themselves to revise their S&P500 earnings numbers upward you should try not to get caught up in the false enthusiasm. Who will be the first to reach $100? (current forward earnings estimates have already broken into the high 80’s/low 90’s). The correct answer is: “Who cares?” Earnings mania could give us just the short term top that makes people remember the “Sell in May” adage.

That said, we still see strength in certain segments of the equities markets. At the top of the ETF list (found here) is the REIT ETF (RWR), followed by Consumer Discretionary (VCR & XLY), Biotech (XBI) and Homebuilders (XHB). The rest of the top 20 is filled with various flavors of US Small Cap indices.

Filed under: Market CommentUS

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