6 Reasons Why Selling in May and Going Away May Not Work This Time Around

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Sell in May and go away is a popular Wall Street adage which refers to an observed seasonal tendency for equity markets to underperform between May and October each year, when compared to the six month period between November and April. In fact, according to some research, since 1990, the S&P 500 has averaged a return of about 2% annually from May to October, versus about 7% from November to April.

So, here are 6 reasons why selling your stocks in May and going away this year might not be the best strategy.

Reason #1: The so-called negative seasonal factors related to the six month period starting in May every year is merely a historical tendency and not a hard rule.

For instance, when looking at historical data for the past ten years, you would have missed some nice returns by selling in May and going away. Some years can be even more exceptional cases. For example, during the months up to March 2020 stocks plummeted on the back of worries about the Covid-19 pandemic, and then rallied sharply well into the period after May due to the unprecedented support provided by central banks and governments. Hence, seasonality can be overshadowed by exogenous effects like a disease and the actions of governments.

Source: Investopedia

Reason #2: Selling has already happened to a great extent this year between January and May.

Equity markets already appear oversold by several standards. The S&P 500′s recent dip to 3,858.87 resulted in the index falling 19.55% from its all-time high — very close to the official 20% decline for satisfying the definition of a bear market. Although nobody can guarantee that markets can’t work lower than these levels, it is not sensible to sell or try to short into an oversold market. Markets never move in straight lines, and in fact some of the most violent rallies tend to happen during a bear market or a recession. Getting caught off on the wrong side can be very costly in terms of foregone returns by staying out of the market, or even losses by betting against the market.

Reason #3: Many stocks, especially tech, got absolutely crushed in recent months and may now be getting ready for a relief rally.

Many technology stocks have lost nearly half their value in recent months. Some others have lost even more than that. Although some companies may not survive in the end, most will in fact do so and they will have a certain value. As market participants realize that good companies have been beaten down well below their intrinsic value on excessive negative sentiment, they will begin forming bottoming patterns. Even though it’s difficult to pick a bottom, there is indication that the process may be underway. For example by looking at the chart on the tech heavy Ark Innovation ETF below, it seems to have bounced off long term support and appears poised to continue in the same direction.

Source: Barchart.com

Reason #4: Sentiment indicates extreme pessimism, setting the stage for a contrarian type of a snap-back rally in equities.

Looking at the Volatility Index (Vix), it seems to be coming off after hitting resistance for a third time between 32–34. As long as it remains subdued and keeps coming off, then it should be supportive for the bullish case going forward.

Source: CNBC

Looking at the The CNN Fear & Greed Index — a composite sentiment indicator, again it indicates extreme fear and possibly market capitulation at these nearly unprecedentedly low levels. Although pessimism could persist for a while, this is not really sustainable for long, meaning that the selling power may be drying up soon. It’s interesting to note that, from a historical perspective, the index has hit a multi-month low of 7 on May 12, an even lower reading than the one observed on the day of the Russian invasion of Ukraine.

Source: CNN
Source: CNN

Reason #5:Stabilizing bond yields may provide support for equity valuations

Some key points by looking at the 10-Year Treasury Note yield and its possible impact on equity markets going forward:

  • The yield seems to have broken successfully above multi-year resistance. As it moved above 3% it has bounced off a previous high at around 3.20% established back in October 2018. As a result, it now seems to be consolidating below this key level.
  • Zooming in on the last couple of years of chart history, it is evident that the yield has followed a nearly parabolic rise from an ultra low level of 0.4% at the beginning of the pandemic in March 2020 to as high as 3.20% this month.
  • Strong up moves such as this, tend to give back some gains after they reach a peak, which seems to be the case at this juncture. Looking at fibonacci retracement levels is a good way to get some idea for possible targets for the correction. An initial retracement of 23.6% at around 2.5% would be a reasonable level to expect. This also coincides with the long-term descending channel, previously acting as resistance, and which would possibly now act as support.
  • As the yield moves lower, it should provide support to equity valuation models, thus helping boost stock indexes.
  • In view of the fact that in the last several weeks both bond and equity markets have been hit hard, it wouldn’t be unreasonable for the correlation to persist but to the upside this time — meaning that both stock and bond prices can move simultaneously higher in the near future.
Source: Barchart.com
Source: Barchart.com

Reason #6: Inflation may be reaching a peak, allowing the Fed to take a less hawkish stance going forward

Annual inflation rate in the US slowed to 8.3% in April from a four decade high of 8.5% in March, but less than market expectations of 8.1%. Despite the ‘downtick’ of the CPI figure for April which shows that inflation may be peaking, it’s more likely that future data will remain above the Fed’s 2% target for quite some time as supply disruptions persist, particularly with respect to energy and food. Even so, and assuming there are no surprises for higher readings, the market has already priced in the Fed’s commitment to handle an inflation rate which is less than or equal to 8%. This will allow the Fed to provide more breathing room for the implementation of its policy. For example, recent reports by Fed Chair Powell have suggested that the Fed is not actively considering 75 bp rate hikes, and instead thinks 50 bp hikes may be appropriate for its June and July meeting, thus providing some support for equity indexes.

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