Economic Monitor: Sell in May and Go Away?

You’ve probably heard the old investing adage, “Sell in May and go away.” It’s an expression based on the theory that the stock market underperforms during the warmer summer months, before coming back six months later with stronger growth. By its logic, one would sell their investments in May and not invest again until sometime around the beginning of November. With the market activity we’ve seen so far in 2022 – and specifically, into the last couple of weeks of April – it’s fair to wonder whether the selling came early this year. 

Presently, there’s a lot happening in the markets and the economy (starting with the Fed meeting last week) that could have big impacts on the direction and magnitude of changes that may occur over the next six months. (One final note on the phrase: It’s important to keep in mind that it’s been around for a while, and with the many advancements in technology and globalization that have been made since it was coined, it can be argued that it’s outdated and doesn’t hold up.) 

As the chart below shows, from 2003 through 2021, there have been only two instances in which the S&P 500 produced a negative total return from May through October, one of them being during the financial crisis in 2008. The average total return for the S&P 500 for the May–October periods in the chart below is 4.58% (including 2008, which saw the largest change in either direction). At the end of the day, the “sell in May” approach is just another attempt to try to time the markets. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the 11 major S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 companies representing a specific sector.

Financial Markets

After the pain felt by many in January and February, March provided some relief, but then April arrived and sent the markets back into correction territory for the second time this year. The Dow Jones Industrial Average lost 4.82% for the month, while the S&P 500 dropped 8.72%. The NASDAQ lost 13.24% for the month and is down 21% for the year. All of the major equity indices were down for the month.

Things like inflation, Fed monetary policy, future rate hikes, and the war in Ukraine are among some of the items causing concern for investors. On the bond side, after a rough 2021 and an even rougher start to 2022, things were not much better. The Bloomberg US Aggregate Bond Index lost 3.79% in April. Year-to-date, that index is down 9.5%. The sell-off in bonds may provide opportunities in fixed income in the future. 

Economy

Following six consecutive quarters of growth, gross domestic product (GDP) declined 1.4%, which was below expectations of a 1% gain for the quarter. The drop was mainly due to a widening and record-setting trade deficit. Rising Omicron cases to start the year also slowed activity, to a degree. 

The good news is, despite the decrease, there’s still strong demand and spending by both business and consumers. Inflation remains a top headline, as March data showed that the Consumer Price Index (CPI) rose 1.2% for the month and 8.5% over the last 12 months. A major contributor to the increase was gasoline, which was up 18.3% for the month of March. Some expect inflation numbers to begin cooling off, in line with what’s been happening with things like used cars and durable goods, although there may be some sectors that continue to see prices rise for some time. Housing prices, too, may finally start to back off, although mortgage rates recently hit their highest levels in a decade, now at over 5% for a 30-year fixed. 

Fed Watch

After some uncertainty about when and how often it may raise rates to combat inflation, the Fed signaled that it would continue to make further movements with rates, and perhaps in larger increments. Last week, the Fed raised rates by 50 basis points, the largest single rate hike since 2000 (the Fed typically changes rates 25 basis points at a time). It may raise them another 50 to 75 basis points at its next meeting in June, and perhaps again at the following meeting in July. The Fed is also expected to announce plans to reduce its balance sheet by $95 billion per month ($60 billion of US Treasuries and $35 billion of mortgage-backed securities). The US 10-year Treasury yield also reached a three-year high in April and may continue to move higher.

Outlook/Summary

Last month’s update noted that bearish sentiment peaked in late February at almost 54%. That dropped to around 28% at the end of March, only to reverse course and peak again at over 59% at the end of April. This means that about 3 out of 5 advisors believed that the market would be negative over the next six months, compared to just around 16% who felt it would be positive. Historically, bearish sentiment runs at about 31%.

Sentiment can be viewed as a contrarian indicator, whereby a significant leaning in either direction, bullish or bearish, could be a sign of a peak or a trough in the markets. Until things start to settle down, sentiment will likely continue to fluctuate widely. 

With this, we maintain our position of staying diversified, while fully invested, protecting the downside risk with funds like hedged equity funds or floating-rate funds. Energy, certain commodities, and dividend paying stocks with strong balance sheets may prosper in this environment, and we will look to take advantage of those where and as appropriate. Bond yields are increasing, which may offer the opportunity to lock in higher rates. We continue to monitor the Fed, the economy, and other news and assess their impacts on portfolios as we make our way through the second quarter. 

To discuss your portfolio, please call the Wealth Management department of the Lake Ridge Bank at 608-826-3570. We look forward to speaking with you soon!