SELL IN MAY AND GO AWAY REMAINS EFFECTIVE ADVICE

DIRECTOR OF CURRENCY RESEARCH, GFT

FORGET merger arbitrage, forget relative strength, forget long/short hedge books. In investing, one simple strategy has been wildly more effective than any modern, sophisticated computer-driven algorithms. You may have heard the old trader manta “sell in May and go away”. I certainly have, but until I looked up its results I never realised just how productive this investment strategy has been.

The “sell in May” strategy refers to the fact that, over the past sixty years, all the gains in the Dow Jones Industrial Average (DJIA) have been made between 1 November and 30 April. In fact if, starting in 1950, you invested $10,000 into the DJIA only during those six months it would have compounded to more than $527,000. The same $10,000 invested during the other six months of the year would have resulted in a net loss of approximately $470. That is a gap so vast that it essentially defines the difference between winning and losing as an investor.

Certainly there are some notable caveats. The “sell in May” strategy applies mainly to the thirty large stocks of the Dow. The smaller, more entrepreneurial businesses on Nasdaq don’t quite fall into the seasonal pattern, with gains lasting through to the end of June. Furthermore, there have been some exceptionally positive years for the “bad” six months. For example the Dow gained 19 per cent in 1958 during the summer, 10 per cent in 1995 and 18.9 per cent as recently as 2009. But those are the exceptions that prove the rule. The bottom line is that, over the past sixty years, seasonality has had a tremendous impact on US equity investing and there is little reason to believe that 2012 will be different.

There are three reasons why stocks may face turbulence over the next six months: slowdown in Asia, high gasoline prices in US and chronic recession in Europe. In Asia, the latest news from China suggests that small-to-medium sized enterprises are continuing to experience decline in demand. The latest HSBC Purchasing Managers’ Index (PMI) manufacturing data, released over the weekend, showed that the index remained below the 50 boom/bust line at 49. This suggests that China will likely remain in a soft landing environment, with growth drifting towards the 8 per cent level. With US companies now selling as much to China as they source from it, slowdown in demand is likely to curtail these companies’ earnings in the future.

In the US, the economy is hampered by painfully high prices at the gas pump. With large swathes of the country paying well above $4.50 per gallon, consumers and businesses are clearly in a cautious mood. This is reflected in the latest labour data statistics, showing that jobless claims have inched uncomfortably away from the 350,000 per week mark. Over the past several weeks, the price of gasoline has declined by about 5 cents, the first time since December that petrol prices have eased. However, unless gasoline prices commence a dramatic decline, the pressure on consumer wallets during the key summer driving season will likely dampen economic activity in the US.

Lastly Europe remains a disaster. The latest PMI data, released yesterday, indicates that the core European economies of Germany and France are unlikely to rebound soon. The data for the region as a whole continues to slip further into negative territory, printing at 47.4 against 49.1 the month prior. The weak PMI reports suggest that growth in core European economies is in peril, undermining any expectations of a rebound to positive GDP in the second quarter of this year. German composite PMI tends to be a strong leading indicator to overall GDP growth and, as it teeters on the edge of the 50 boom/bust line, it indicates that Europe’s leading economy may remain in recession for the near term.

None of this bodes well for stocks which are likely to remain under pressure as the summer proceeds. With all three areas of the globe seeing economic slowdown, the recent rally in equities could be easily unwound as we approach autumn. This is why I believe that “sell in May and go away” remains as good advice in 2012 as it has been for the past sixty years.