Does May Mark the Start of Market Weakness?

PERSPECTIVES: Should investors expect a period of weakness as two stock market themes coincide in the coming months?

IG 30 April, 2013 | 1:11PM
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This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, IG Markets discuss whether investors should expect a period of weakness as two stock market themes coincide in the coming months.

With the strong showing of markets in the first quarter now out of the way, investor attention is turning towards performance for the rest of the year. In the months to come, however, markets face a difficult period as two stock market themes coincide.

The first of these, and the oldest, is the adage ‘Sell in May, and go away, and don’t come back until St Leger’s day’. This long-established saying essentially argues that investors would do well to sell all their holdings at the beginning of May and wait out the summer until a time close to the second Saturday in September, re-entering the market around the time of the St Leger’s day races.

The second theory, now dubbed the ‘Spring Swoon’, suggests that the global economy is facing a regular bout of weakness that precedes a volatile period for risky assets such as stocks and commodities.

Sell in May

Seasonal weakness in the stock market is a long-established theory, with plenty of evidence to support it. One study from New Zealand even managed to find patterns in the British market going back to 1694.

However, the real focus has been on US markets. The Dow Jones has returned an average of only 0.3% during the May-September period since 1950, compared to 7.5% during the October-April period. Summer holidays and higher inflows of funds during the winter months have been cited as reasons for these periods of relative under- and out-performance.

The graph below shows the average performance of the FTSE 100, Dow Jones and

S&P 500 in the May-mid-September period, rebased so that 1st May in each year has a value of 100. 

(Click graph to enlarge)

 

To link back to our discussion of the ‘Spring Swoon’, the past three years have seen the ‘Sell in May’ effect in action. From the beginning of May to the summer low, the average decline for the Dow Jones, S&P 500 and the FTSE 100 has been in the region of 13%.

It is important to note that markets do recover their summer losses, but there is a case to be made that investors might wish to take advantage of the seasonal underperformance of markets in this period by shorting indices during the summer and then looking to establish new longs as the autumn gets underway.

The Spring Swoon

In 2010, 2011 and 2012 global economic data experienced a sustained downturn in the second quarter. Figures from around the world showed that activity was slowing after a reasonable start to the year.

The graph below uses a composite PMI compiled by investment bank JPMorgan that covers major indices from around the world. In the three boxes marked ‘A’, ‘B’ and ‘C’ we can see a period of economic weakness. In the US this has seen a reduction in new job growth, falling retail sales and a drop in manufacturing output.

This year the slowdown may be more pronounced thanks to the budget tightening that has taken place. With the US government still locked in an endless debate about the correct balance of spending cuts and tax increases.

Even in a world where central banks are committed to expansive policies of Quantitative Easing, economic data still matter. After a sustained period in late 2012 and early 2013 of improving data we have seen a weakening of growth, with US nonfarm payrolls being a case in point. The US economy created just 88,000 new jobs in March 2013, down from 164,000 in January and an impressive 254,000 in February. The March reading was the lowest since June 2012, and came as a nasty shock to those that had expected continued improvement from the world’s largest economy.

This trend is now three years old. At present, the JPMorgan global PMI is not showing signs of weakness, but we have not yet had the April reading. The March figures showed slight improvement in the composite, services and manufacturing PMIs, but only when we have the April and May data will we know for certain that the global economy has hit another weak period.

The Months Ahead

Using data from IG’s Insight centre (data as of 4.30pm, 24 April 2013), we can see that clients expect a new weak period for markets in 2013. Clients are net short on all three indices mentioned in this report, and with worries about the health of the global economy mounting they may be proved right.

IG Markets Disclaimer
No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. IG Markets Limited is authorised and regulated by the Financial Services Authority (FSA No: 195355).

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IG

IG  specialises in Contracts for Difference (CFDs), spread betting and FX. It is headquartered in London and part of IG Group.