If I hear one more person spout that line, I think I’ll go nuts. Suddenly, because this cliché has worked for the past two years, it has become Gospel to believe it will happen again this year. Investors should be wary.
Back in July, 2008 I wrote in “Myths of the Market”:
“Sell in May and Go Away,” is one often quoted saying that implies that stock market returns are higher in the November-April period than in the May-October months. After 27 years experience in global markets, I tend to agree. My belief is backed up by multiple studies that indicate that in 36 out of 37 developed and emerging markets this indicator works the majority of the time. Although no one can provide one single cause for this, I believe it has something to do with summer vacations, especially in Europe, where the effect has been noticeable since 1694.”
As a contrarian, when everyone is expecting the same thing, (in this case, a sell-off in the markets lasting into the fall), I tend to lean the other way. There certainly are plenty of good reasons to be concerned that this third year will be the charm. Questions over QE3, the on-going Euro crisis, a slowdown in China, an incredible first quarter rally in stocks—all of these would indicate we need a correction or at least a healthy pull back.
The most convenient thing for all of us would be to cash in our chips, get to the sidelines and enjoy our summer. If you had done so in 2010, you would have missed a meager 1% gain in the markets between April 30 and October 31. In 2011, you would have dodged a 6.7% slump in the averages. But markets usually do what is most inconvenient for the greatest number of investors.
A recent report from Ned Davis Research pointed out that the Selling May strategy doesn’t work nearly as well when it occurs in a presidential election year. They looked at every presidential election since 1900. Investors on average would have missed a hefty 4.4% gain as measured by the Dow Jones Industrial Average in those years by selling in May. If an incumbent wins, the gains are even higher (7.6%).
Now, before you reverse course and buy everything in sight, a word of caution is appropriate. The same study did show that, on average, a correction did occur during the second quarter of presidential election years. The duration of the pull back is what differs.
Usually, a summer rally occurs after the second quarter sell off in an election year. When the incumbent party has lost the election, the summer rally fizzled out and the Dow made a new low in late October, followed by a weak year-end rally. When the incumbent won, the summer rally was stronger and the pull back in the fall was mild, followed by a strong gain into the end of the year.
The explanation for the differences in these presidential election year markets comes down to uncertainty. That uncertainty is compounded when the economy has been weak, as it is now. Leadership in times like these is extremely important to market investors. Some would argue that the incumbent (the devil you know) is preferable to one you don’t know, who may or may not, usher in successful policy changes. The presidential candidate’s party affiliation did not appear to have any bearing on the results.
So the moral of this tale is that there may still be a sell-off between now and the end of June, but politics will have an inordinate influence on what happens this summer and fall.