Sell In May And Go Away?

May 04, 2011

A potential fully invested ETF portfolio that could help investors control their risk exposure.


The stock market adage “sell in May and go away” is based on the historical tendency for stocks to generate most of their positive returns during the six-month period from November 1 through April 30. Since 1950, the Dow has appreciated 7.4% on average during this favorable period, versus only a 0.4% average return in the May 1 through October 31 interval. It is not difficult to imagine this seasonal pattern playing out again this year. The stock market was very strong in the favorable six-month period just ended. The Dow gained 13% from November 1 through April 30. Looking out over the next six months, there are plenty of factors that could derail the bull market, including:

1. The end of Fed money printing (for now anyway). When the Federal Reserve completes its $600 billion debt monetization program at the end of June, it will no longer be injecting $75 billion per month of newly printed money into the financial system. To be sure, the Fed will not be tightening monetary policy by either restoring a positive interest rate or reducing its bloated $2.7 trillion balance sheet. Nonetheless, the end of so-called quantitative easing will undoubtedly test investor risk appetites and the powerful upside momentum of stocks since the program was announced.

2. Peaking leading economic indicators. The economy has positive momentum now, but unprecedented monetary and fiscal stimulus will begin to be withdrawn in the months ahead, and it remains to be seen how the economy will fare. The stock market leads the economy, and the U.S. economy in 2012 is very likely to be weaker than in 2011, due in part to the expiration of stimulus enacted in late 2010 (i.e., reduced Social Security withholding and 100% depreciation on new capital investment).

3. Inflation pressures unlikely to be “transitory.” The Fed continues to obfuscate the inflation problem and is out on a limb relative to almost every major central bank in the world. Inflation pressures are much more likely to be “sticky” than “transitory.” Given that the U.S. average price of gasoline is $3.94 today versus $2.80 six months ago (a 40% increase), Americans know that the Fed’s story doesn’t add up. Although monetary policy remains extraordinarily loose in the U.S., most foreign central banks are tightening monetary conditions to confront obvious inflation pressures, which raises risks for assets tied to the global growth and reflation theme.

4. U.S. debt-ceiling turmoil and the recognition that we are entering the endgame of the debt issue. The country and its politicians are finally acknowledging the scope and urgency of our fiscal problem. There is a growing recognition of the necessity of an overhaul of the federal budget and entitlement programs, combined with increased federal tax revenue. There is no intellectual mystery involved in balancing the budget in a centrist fashion, but the political parties are intransigent and deeply entrenched. Unless the bipartisan “gang of six” in the U.S. Senate can save the day, the parties appear incapable of compromising around a plan for fiscal sustainability. This would be a tragic crisis of leadership. The issue for the markets is that we can’t take enough out of the debt without hurting the economy, but if we don’t act, we continue down the immoral path of mortgaging our economic future and debasing the dollar. Our fiscal situation is clearly unsustainable and dangerous, but for the time being we face neither an imminent collapse nor a probable solution, which creates a perplexing investment environment indeed.

5. U.S. dollar in the danger zone. Given the “print and spend” policies of the U.S., it is not surprising that the U.S. Dollar Index is testing historic lows (see Exhibit 1). On the back of deeply negative “real” interest rates, in contrast to the tightening posture of most foreign central banks, the dollar has recently been depreciating at an increasingly rapid pace. Sentiment is very bearish against the U.S. dollar, and the anti-dollar trade is crowded. Contrarian investing suggests that at least a temporary low in the USD should be close at hand, but given how dollar-bearish our policies are, and how the world is looking for ways to reduce USD exposure, I wouldn’t want to call a bottom. A break to new all-time lows in the USD has the potential to be very destabilizing to global financial markets.


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