How to tell whether rough winds will shake the market’s darling buds of May

The saying “Sell in May, go away and come back again on St. Leger day” is one of the oldest of all market rules of thumb and after a tricky start to the year it is one which may attract more attention than normal as 1 May approaches.

This column has taken the plunge and burrowed through performance data for the FTSE All-Share stretching back to 1965 to see whether “Sell in May” has ever been worthy of consideration by investors as a strategy – and therefore whether it is one to ponder now.

This year, the St.Leger, the world’s oldest “classic” horse race, will be run at its usual venue, Doncaster’s Town Moor racecourse, on Saturday 10 September. 

We have therefore studied the FTSE All-Share from 1965 onwards, to test out the market saying, by looking at the performance of the index in three distinct time periods: 

• 1 January to 30 April
• 1 May to 10 September
• 11 September to 31 December 

for each of the last 51 years. In conclusion:

• Yes, “Sell in  May” has made sense on average since 1965, although note the importance of the phrase “on average”. Over the past 51 years the 1 January to 30 April period has been the most rewarding for investors, while the 1 May to 10 September has been the most challenging.

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

• No, “Sell in May” is not a fail-safe mechanism. In the past 51 years, the market has followed the pattern prescribed by the “Sell in May” saying of rising in the first four months, then falling to September and then rallying again on just 14 occasions – so the adage doesn’t work each and every year, even if the long-run averages work out okay. Investors who sold in May would have missed out on double-digit rallies no fewer than 10 times - 1968, 1971, 1977, 1980, 1987, 1989, 1995, 2003, 2005 and most recently in 2009.

The moral of the tale is perhaps therefore investors should not try to be too cute and test out their market timing skills - in the end buying in January, selling in May and buying again in September has only worked out 27% of the time since 1965. 

There’s no guarantee that the old pattern will work, plus such trading involves paying stamp duty, traders’ spreads and brokers’ commissions, as well as potentially tax, so investors’ frictional dealing costs would start to rack up pretty quickly, eating into their portfolio returns.

There is also the danger investors could miss out on valuable dividend payments as you trade in and out of the market. And it has been the harvesting and reinvestment of those dividends that has been the secret to making the most of equities over the very long term, at least according to the FTSE All-Share’s history since its inception in April 1962.

Quick start needed

There is one final trend which emerges from our analysis of the FTSE All-Share’s seasonal performance since 1965 – namely that if the first four months prove fallow, the rest of the year tends to prove rather difficult. 

Between 1965 and 2015 the FTSE All-Share fell just 14 times – and on 10 occasions the index delivered a drop for the full-year, with the average capital loss across all 14 occasions coming in at a nasty 10.8%.

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

However, there are still four gains in there and three of those came among the last four bad starts to a year, so there are no guarantees history will repeat itself.

Nevertheless, this seems an opportune time to revisit four other, tried-and-tested market indicators to suggest whether the latest stock market rally has legs or not, especially as the FTSE All-Share is only around flat for the year as we approach the first of May.

• Transportation stocks versus utilities

Regular readers will know this column is a great believer in the power of transport stocks as an indicator of both economic activity and also stock market sentiment. One wrinkle here is to look at the relative performance of the transportation names relative to the stodgier, more defensive utilities. 

If the transports are doing better, this would usually be an encouraging sign and – for the moment at least – this indicator looks to be going the right way.

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

• Big caps versus small caps

Investors’ concerns over the EU referendum and the implications of a stay or leave vote could be muddying the waters here a little, but generally small caps outperform when risk appetite is elevated and the big caps do better when fear rather than greed is setting the tone. 

For the moments, the big cap/small cap ratio is going nowhere fast, so the next inflection point could be a useful signal:

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

• Consumer discretionary stocks versus consumer staples stocks

Consumer discretionary sectors like media, travel and leisure and general retailers tend to outperform more defensive, less economically sensitive areas like tobacco, beverages and food retail when things are going well – and vice-versa. 

For the moment, Consumer Staples are outperforming the Discretionary plays. This ties in to the wretched news about BHS, where 11,00 jobs are at risk, and raises the baffling issue of why general retailers in particular are doing so badly at a time when the oil price is weak and wage increases are outstripping inflation, as both should fill consumers’ pockets with ready cash. 

Yet retailers (as well as travel operators, hotel groups, restaurateurs and bookmakers) must satisfy price sensitive, internet savvy consumers, even as they contend with cost pressures created by the Living Wage and the need to build and maintain a state-of-the-art website.

There may also be a bigger picture here. Perhaps we are entering the later stages of a credit cycle whereby consumers are unwilling - or unable – to take on much more credit as they prioritise daily needs such as rising property prices and rents, the long-term need to provide for pensions or healthcare or pay off debts incurred during their student days.

Whatever the reason, further marked outperformance of discretionary names by the staples would be a potential warning signal for the broader UK equity market.

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

• The yield curve

The UK’s yield curve, as defined by the gap in the yields offered by two- and ten-year Gilt yields, has been steepening – on this occasion, 10 year yields have been going up faster than for the two-year. 

Again, this could reflect concerns over the outcome of the EU referendum, but Government bond yields also tend to sneak up when inflation expectations are rising and the economy is going well, in anticipation of a possible future interest rate increase.

As such, the steepening of the curve could be a good sign and one that may sit easily with a rally in the stock market, though any fresh flattening (where ten-year yields fall more quickly than those on the two-year) would potentially be a less encouraging sign.

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

Russ Mould
AJ Bell Investment Director