US equity bulls dismiss May jitters

Following the old adage “sell in May and go away” worked well enough for the past two years. Investors are asking whether 2012 could make it three years in a row.

Against an inauspicious backdrop of slowing US growth and renewed nervousness surrounding the eurozone debt crisis, selling out of an S&P 500 index that has rallied more than 11 per cent this year, but stalled in April, could turn out to be a savvy move.

Statistically the summer months pale in comparison with the performance of stocks in winter and spring. Since 1950, the S&P 500 has risen an average of 1.1 per cent in the six months from May to October versus a gain of 7 per cent from November to April, according to the Stock Trader’s Almanac. May itself has been marked by big gains and losses at various times.

Indeed, the rationale for selling in May and leaving the market for the summer is often a winning trade.

“Historically, August and particularly September have not been good months for stocks,” says Jeffrey Hirsch, editor-in-chief of Stock Trader’s Almanac. “That completely skews the average.”

Investors on Tuesday were looking on the bright side, with the S&P rallying earlier on better manufacturing data. This rebound came after the benchmark ended April with a loss of 0.8 per cent, its first negative month since November.

Whether April’s lacklustre performance was a pause that ultimately pushes the market higher, or a prelude to a stormy summer is the big question among investors.

“History tells us markets don’t pay attention to risk until May,” says Walter Zimmermann, chief technical strategist at United-Icap. “Now, 2012 seems to be one of those classic textbook cases: going into May, most people are still very long and very bullish on stocks.”

Others say that investors expecting another May sell-off could be surprised by a resilient US market.

“I don’t subscribe to the idea that because something has occurred in the past it necessarily will occur again,” says Hersh Cohen, chief investment officer at ClearBridge Advisors.

While bulls point to signs of stability in housing and expect stronger earnings on the back of an accelerating economy later this year, bearish investors are focusing on external macro-economic threats and the dour message being sent by a 10-year Treasury yield camped at below 2 per cent.

Any escalation of the problems facing the eurozone could impair S&P company profits. “The US is in somewhat better shape but data are also far from great, and we are still very exposed via exports to Europe,” says Mr Zimmermann. He does not rule out a summer sell-off that could see the S&P drop at least 20 per cent.

But there has been a silver lining, according to some analysts, in that the wider market has clawed back most of its losses since it dropped nearly 5 per cent from its high of 1,422 early in April.

“Any type of 4 to 5 per cent correction is a buying opportunity as there is a lot of cash on the sidelines and people missed the start of this year’s rally,” says Anthony Conroy, head of trading at ConvergEx Group.

Any downside facing the US market could also be limited by the so-called “Bernanke Put”. In the event of weaker US growth marked by lacklustre job creation, share prices could derive support from further quantitative easing from the Federal Reserve.

“US economic momentum is slowing, European sovereign stress is rising and Bric growth is decelerating,” says Alec Young, global equity strategist at S&P Capital IQ. “However, US equities are supported . . .  equity markets assume QE3 will be made available should growth deteriorate further.”

The S&P’s price-earnings multiple of 14 times trailing 12-month earnings could be supportive, too. This was at 16 times in May 2011, and at 14 times for May 2010.

“Compared to either 2010 or 2011, the stock market seems much more cheaply priced and investor sentiment seems much less exuberant,” says Jim Paulsen, chief investment strategist at Wells Capital Management. “Its cheaper current valuation, both on an absolute basis and relative to bonds, makes the stock market much less vulnerable to a serious swoon.”