The Case for Selling in May

By on May 2, 2011

There is an old adage that investors might as well sell in May because historically the stock market’s performance during the May 1st through October 31st time period is sub-par.   The “sell in May” phenomenon has been observed throughout the world, showing a strong tendency for relative market weakness in 36 of 37 markets where it was studied by Boumann and Jacobson in 2002 (link). 

There are a number of reasons the market might be ripe for, if not a bear market, a much weaker six months than investors expect.  The stock market faces some serious potential headwinds including:

  • Gas prices approaching $4.00 a gallon crimping consumer spending in other areas of the economy.
  • The Fed concluding its quantitative easing (QE) program in June leading to potentially higher interest rates.
  • New FDIC rules on banks dampening the financial sector’s profitability.
  • A weakening dollar leading to inflation fears and another impetous for higher interest rates.
  • No real sign of stabilization in the housing market.
  • Profit margins at historic highs which could begin reverting to the mean.
  • The stock market has been very strong over the past six months (up 15%), setting up for potential weakness.
  • Bullish sentiment is high with most market partipants expecting a strong finish for the year.

The positives for the market include the fact we’re in the 3rd year of the presidential election cycle which is the strongest of the four, while earnings of multi-national companies continue to accelerate on a recovering global economy.  Sam Stovall, chief investment strategist for S&P, says the market rises 70 percent of the time in the May-October period in the 3rd year of the presidential cycle.

Market weakness over the next six months is certainly not a given, but the scale appears to be tipped in favor of the bears.  It may be an opportune to lighten up on equity exposure; especially those areas that have shown gigantic gains since the bottom over 2 years ago.  The market should get a temporary boost from the announcement of Osama bin Laden’s death providing a window to do some selling at elevated prices.

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