Seasonal narratives in equity markets

by George Hatjoullis

There is a popular seasonal narrative in equity markets which begins ‘sell in May…’, though when you buy back seems to depend on which market. Seasonal patterns do exist in financial markets for various quite rational reasons. However, the ‘sell in May‘ adage is often used rather casually.

One of the best market data-miners is David Schwartz, who also occasionally writes an interesting piece in the FT under the title of ‘Trader’s Diary’. The piece published May, 3, 2013 is worth a read (http://on.ft.com/13bWxAe). It relates to the UK equity market and he notes that in relation to the May to September seasonal lull;

… prices rise three quarters of the time if a bull market is running.

The issue is therefore not seasonality but is a bull market running. Interestingly this accomplished market historian concludes:

My own guess is that shares are vulnerable to a decline due to steadily weakening economic conditions and the fact that prices continue to show signs of being overextended after a healthy start-of-year rally. Sell in May has nothing to do with these suspicions, however.

He is bearish because of the ‘poor GDP outlook’ narrative that I discussed in my blog ‘Non-farm payroll and the S&P 500: which narrative?’. So much for seasonality. Indeed it is not entirely clear whether ‘sell in May’ even applies to the S&P 500. The following article published by Equity Clock (http://bit.ly/13XWNSa) attributes the saying to seasonal patterns in base equity metals:

Base metal prices as well as base metal equity prices tended to peak early in May and bottom near the end of September.

This is consistent with the softening of base metal prices already evident. The striking thing about the May to September period in the wider North America equity indices is the lack of a consistent seasonal pattern. This makes the period look weak compared to the September to April  period which has a positive seasonal market bias. Not positive does not necessarily mean negative.

From personal experience, the problem with the summer months is largely summer holidays. There are less traders at their desks and often junior colleagues are looking after the books. The markets ‘thin out’ and become more vulnerable to extreme price moves given a suitable shock. However, the shock can be positive as well as negative. There is also a tendency to reduce risk exposure so if investors and traders are ‘long’ there may well be some selling. It is best to judge each summer on its merits and note the potential for extreme price moves.

The first  question to ask is whether the US equity market is ‘long’. This expression needs some clarification as it seems to confuse even experienced market participants. One does not measure anything out of context. The market is only ‘long’ if the majority of participants are close to fully invested. This is not obviously the case. The equity markets have climbed a ‘wall of worry’ against a constant negative growth narrative. It is unlikely that the majority of investors are anywhere near fully invested. Cash and bond holdings are too high. Now in part this is structural because regulatory changes require a permanent change in asset allocation away from equities in some jurisdictions. However, this is not be the whole story.

The second issue is; are we in a bull market? The S&P 500 just made a new all time high despite a persistent negative growth narrative. Bull markets make higher price highs and higher lows. They trend is up albeit in wide channels. The prima facie evidence from the chart is that we are in a bull market and the fact that no one is saying this supports the idea. The time to worry is when everyone is bullish!

Third, the negative growth narrative does not quite seem to fit the evidence. The US economy is creating jobs and unemployment is falling. Growth may not be exploding but it looks quite steady and solid. In my previous blog (see above) I constructed a positive narrative for the growth outlook. I also noted that ‘bears’ sound like buyers-on-dips rather than sellers. A correction could ensue in the summer months but it may be an opportunity rather than a problem. Moreover, it may not go very far.

Finally, the Federal Reserve may be looking to exit the easy money policy. It is, however, in no hurry. It will almost certainly err on the side of caution and allow easy money a little longer than the data suggest is strictly necessary. The time to worry about equity markets is when it is evident that the easy money is no longer necessary.

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Postscript: David Schwartz notes that FTSE has fallen between May 6 and May 31 for 10 of last 12 years. FTSE futures closed 6532.5 on May 3. Worth monitoring.

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