The Month Ahead

Our regular overview highlights the key events in the markets last month and what to look out for in May.

With the strong showing of markets in the first quarter now out of the way, investor attention is turning towards performance for the rest of the year. In the months to come, however, markets face a difficult period as two stock market themes coincide.

'Sell in May and the 'spring swoon'

The first of these, and the oldest, is the adage ‘sell in May and go away, and don’t come back until St Leger’s day’. This long-established saying essentially argues that investors would do well to sell all their holdings at the beginning of May and wait out the summer until a time close to the second Saturday in September, re-entering the market around the time of the St Leger’s day races.

The second theory, now dubbed the ‘spring swoon’, suggests that the global economy is facing a regular bout of weakness that precedes a volatile period for risky assets such as stocks and commodities.

'Sell in May'

Seasonal weakness in the stock market is a long-established theory, with plenty of evidence to support it. One study from New Zealand even managed to find patterns in the UK market going back to 1694.

However, the real focus has been on US markets. The Dow Jones has returned an average of only 0.3% during the May-September period since 1950, compared to 7.5% during the October-April period. Summer holidays and higher inflows of funds during the winter months have been cited as reasons for these periods of relative under- and out-performance.

The graph below shows the average performance of the FTSE 100, Dow Jones and S&P 500 in the May – mid-September period, rebased so that 1 May in each year has a value of 100.

To link back to our discussion of the ‘spring swoon’, the past three years have seen the ‘sell in May’ effect in action. From the beginning of May to the summer low, the average decline for the Dow Jones, S&P 500 and the FTSE 100 has been in the region of 13%.

'The spring swoon'

In 2010, 2011 and 2012 global economic data experienced a sustained downturn in the second quarter. Figures from around the world showed that activity was slowing after a reasonable start to the year.

The graph below uses a composite PMI compiled by investment bank JP Morgan that covers major indices from around the world. In the three boxes marked ‘A’, ‘B’ and ‘C’ we can see a period of economic weakness. In the US this has seen a reduction in new job growth, falling retail sales and a drop in manufacturing output.

This year the slowdown may be more pronounced thanks to the budget tightening that has taken place. Moreover, the US government remains locked in an endless debate about the correct balance of spending cuts and tax increases.

Even in a world where central banks are committed to expansive policies of quantitative easing, economic data still matters. After a sustained period of improving data in late 2012 and early 2013, we have since seen a weakening of growth, with US non-farm payrolls being a case in point. The US economy created just 88,000 new jobs in March 2013, down from 164,000 in January and an impressive 254,000 in February. The March reading was the lowest since June 2012, and came as a nasty shock to those who had expected continued improvement from the world’s largest economy.

The outlook for May

The current uptrend has faced several threats over the past four months. Yet, each time, it has managed to rediscover its strength and push higher. Only time will tell if we will see 2013 repeat the patterns seen in recent years. At present, the JP Morgan global PMI is not showing signs of weakness, but we have not yet had the April reading. The March figures showed slight improvement in the composite, services and manufacturing PMIs, but only when we have the April and May data will we know for certain whether the global economy has hit another weak period.

It is important to note that markets do recover their summer losses, but there is a case to be made that investors might wish to take advantage of the seasonal underperformance of markets in this period by shorting indices during the summer and then looking to establish new longs as the autumn gets underway.

Disclaimer: IG provides an execution-only service. The material on this website does not contain (and should not be construed as containing) investment advice or an investment recommendation, or a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of the above information. Consequently any person acting on it does so entirely at his or her own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. This communication must not be reproduced or further distributed.