Rudi's View | May 03 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck
April has been very kind to most equity markets around the globe. US shares, with the exception of NASDAQ, have finally recovered the ground lost in the post-millennium internet and technology meltdown. In Australia, the S&P/ASX200 index briefly landed above 6200 – its highest level ever.
But as May approached most equity markets started to weaken slightly. The very first day of the new month saw Australian shares lose a little more of their value, inspired by losses in Asia and overnight in the US.
Most investors will still remember it was in the second week of May last year that global equity markets fell victim to an old-fashioned correction led by a sell-off in miners and explorers and other natural resources related stocks.
One year later and some experts are again calling for a correction. Some say the markets have again run too far too fast and letting off some steam would be but healthy. Others use technical analysis to advocate the brief correction global markets experienced at the end of February was too shallow and too brief. They too believe a second correction should be considered but a given. However, this time the losses should be more serious.
The Chinese equity markets, which inspired the global sell-down in late February and early March, have run as hard as before post their shock losses on February 27. In so far that some experts who are following the market closely from within China are already predicting another steep fall – but when? What will be the trigger this time? And will the rest of the world meekly follow Chinese equities in their fall?
Another group of experts, led by the resources team at Merrill Lynch, sees a strong parallel between 2007 and 2006. They firmly believe spot prices for base metals are again unsustainably high and a sharp correction could occur any time from here on.
However, it would seem the most compelling argument why May might bring us another correction in global equity markets is the fact that May is simply… May!
The old saying “Sell in May and go away” is oft used to mark the cut off between the buoyant times and the not so buoyant times in any given calendar year for investors in share markets. Dependent on regional variations, the saying implies it is better to stay away from the markets between May and September or between May and October.
Regional variations are shown via the different sentences that follow the “Sell in May and go away” opener. Some investors will tell you “but remember to come back in September”, others will say “but buy back on St Leger Day” (referring to a horse race in mid-September in the UK).
In the US, the principle is simply referred to as the “Halloween Indicator” implying the period from October 31 through April 30 generates much higher share market returns than the other half of the year.
While some experts may regard the “Sell in May” saying as nothing but some unproven superstition, many others are fierce defenders of the adage. Type “Sell in May” in the google search engine and you will find there are numerous commentators, blogs and financial websites around that advocate the merits of the “Sell in May” investment strategy. Most of them concentrate on equity markets in either the US or the UK.
The historical analyses and data on display are impressive, if not utterly convincing. Data compiled by stock market historian David Schwartz shows the UK market recorded its double digit gains throughout the 1980s and 1990s almost entirely between November and April. The period May-September, also referred to as the “summer months”, on average and despite being the annual dividend season, produced no gains at all over the two decennia.
Figures cited for US shares are similarly impressive. According to some surveys, the Dow Jones Industrial Average (DJIA) added a total 9,471.26 points between November and the end of April over the 50 years from 1924 to 2003. The remaining months over the same period only managed to add 850.94 points (not a typo). Similar data are available for the S&P500 index and NASDAQ.
This obviously raises the question: what about Australian shares?
It would seem the experts are divided over the seasonal pattern in the Southern hemisphere. Some believe the principle is universal, but others advocate Australian shares often perform very well during northern summer periods, suggesting it may well be that the opposite applies down under.
Two academics in the Netherlands, Sven Bouman and Ben Jacobsen, initiated what is likely to be the most comprehensive study into the adage on a global scale thus far. The findings of the study were published in December 2002 in a report called The Halloween Indicator, “Sell in May and Go Away”: Another Puzzle.
The results of the study were equally impressive. Bouman and Jacobsen found the “Sell in May” effect was present in 36 out of 37 countries surveyed, the sole exception being New Zealand.
When comparing the principle with other wisdoms such as the January effect and the Monday effect, “Sell in May” proved much more robust, statistically significant and near universal (most investor wisdoms only apply to developed markets, but Bouman and Jacobsen found “Sell in May” also applies across emerging markets).
Equally important, the survey found the effect was large enough to offset transaction costs of buying and selling into the market (unlike some other investor wisdoms).
Unfortunately, one of the outcomes was also that return differences between the various periods were the most pronounced in the US and in Europe but even in those markets the differences between both periods seem to have become less in recent years.
Bouman and Jacobsen concluded adopting a Halloween strategy would beat the market index in nearly every investigated country, including Australia.
However, FNArena’s own analysis of returns on the Australian share market over the five years post this study shows the annual pattern in the local market hasn’t been as clear cut as suggested by the Bouman and Jacobsen study.
What seems to stand out is that a longer period of share market gains is more likely to be followed by a correction. Prior to the May sell-off last year share markets had been enjoying strong gains in the months prior to the event. February 2006 generated a negative return. This year February delivered a minor scare (but still a small positive return in Australia).
Shares may well retreat this month but experts, such as the economists at Macquarie Bank, remain of the view that the longer term horizon for share markets is still a positive one as long as “runaway global liquidity growth” remains intact and continues to suppress global risk aversion.
Thus as long as the US economy is transmitting signals of recovery, and US corporate profit growth remains sufficient to sustain employment growth, global liquidity growth will ensure any hit to equity markets is unlikely to last long, the economists argued this week.