Wealth management is replete with adages distilling investment wisdom. One of the most enduring is the rather obscure-sounding “Sell in May, go away and come back for St Leger day”. This expresses the belief that the best returns are to be had between autumn and spring, and that investors should take profits as summer really gets under way and not return to the markets until the time of a horseracing event traditionally held around 8 September.
Archaic though this saying sounds, historically it has actually held largely true – well, at least on average, if not year in, year out. Academic research[i] has shown that over roughly a century markets all over the world have tended to return 5% over the winter months, compared to just 1% May to October.
This year, investors may well be feeling the urge to “go away in May” even more strongly than usual.
Since the panic-driven falls at the beginning of the COVID-19 pandemic in 2020, there has been a blistering year-long equities rally that has seen market high records smashed again and again. Valuations are elevated, some might even say worryingly so in places, and investor exposure to technology is near historic highs. Many are now expecting a pause for breath.
We have, of course, already seen something of a reality check. In early May, major indices fell 2-3% as inflationary fears really began to rattle investors, their fear being that runaway inflation will lead to a tightening of monetary policy harmful to risk assets. Tech stocks took much of the hit in this sell-off.
With many valuations seen to be frothy (if not in outright bubble territory) and the “go away” period now in full swing, the recent sell-off was arguably to be expected amid some concerning inflation indicators coming out of the US, like labour shortages. This “idiosyncratic” sell-off having occurred, the worry is now that one more systemic in nature is brewing.
The issue at stake is whether the risk/reward profile of equities is offering sufficient compensation in the near term. Investors certainly wouldn’t get out of bed for the 1% average summer return if it weren’t for the promise of greater gains the rest of the year. Many experts are very upbeat on the outlook for equities over the next 12-18 months, with even bigger market highs predicted, but the coming 3-6 months call for caution. Modest equity underweights are now commonly spoken of.
More broadly, the intelligentsia are advocating that investors take this as an opportunity to rebalance their portfolios and position them for the next economic phase as the global recovery (hopefully) goes full speed ahead.
Rotation and rebalancing
The rotation into recovery-led themes, which began in the first quarter, has been put on hold and therein could lie opportunities. A defensive hangover is in evidence from the darker days of the pandemic, which means that economically sensitive cyclical stocks are still relatively cheap in comparison.
There is even a case to be made for “super cyclicals”[ii], particularly in travel (think airlines, accommodation and cruise companies). These may labour under high fixed costs, low margins and unstable demand, but can translate relatively modest gains in revenue into very sharp upticks in margins due to what’s known as “operating leverage”.
Stay in the game
The shift from growth to value stocks is now also well under way, with their attractiveness growing in line with economic reflation. Yet the focus needs to be on high-quality value stocks, the experts are saying, as these are still trading at a discount and hold out the prospect of strong Earnings Per Share growth without the risks associated with junk.
And what of technology? These equities have indeed borne the brunt of the recent sell-off and further cooling can be expected as the frenzied buying caused by the pandemic gives way to a more discerning differentiation between companies and sub-sectors once the recovery gathers pace. What this could mean for savvy investors is an opportunity to capitalise on further dips to build their positions in quality names. The digital transformation of every area of life is really only just beginning, after all.
In short, the maxim of selling in May could have merit this summer, but probably shouldn’t be taken as a blanket exhortation to trim equity allocations across the board until the nights start drawing in again. Rather, this period of 2021 is an opportunity to hit pause, rebalance portfolios and possibly take advantage of any buying opportunities that emerge. We’re all in dire need of a holiday at this point, but keeping your head in the game as others retreat could be great for your profits long term.