Sell in May?

What’s the story with ‘Sell in May’?

This popular seasonal trend gains a lot of interest when the calendar turns from April to May. Part of the reason, I believe, is that when markets have had a good first quarter of the year, investors then look for ‘reasons’ to sell, as minds shift to summertime and vacations. The part that does not get nearly enough attention if one chooses to follow this strategy is when to buy back those positions sold? There’s no exact day or bell that goes off, and buying back can often be more challenging, especially if markets have moved higher and the investor wants to wait for it to come back down to their sell price. But it does not mean sell everything and then buy back in later. ‘When’ is often more difficult. March 2020 was a lesson on timing, as anyone who sold in March waiting for things to get better missed a terrific and unexpected turnaround. The “sell in May” adage is based on the long-term average trend of the stock market underperforming for the six months beginning in early May, compared with the other six months of the year. Looking at the adjusted six-month period from May 6 to Oct. 27 from 1950 to 2020, the S&P 500 index has produced an average loss of 0.1%, but has been positive 63% of the time. That’s significantly weaker than the 7.7% gain and 72% frequency of being positive in the favourable six-month period for stocks, which runs from Oct. 28 to May 5, during those same years. It’s generally believed that October is a more favorable period for equities, while May can be unfavorable. But that does not mean all equities and as noted above, timing is always difficult and there can be tax consequences to consider with selling stocks as well. Many companies can still perform well. Last year, coming off the March selloff and out of a recession, the markets had a tremendous period during the summer and fall months.

The start to 2021 resembles 2013 and 2017, where the market broke out higher from a wide base. These charts from Sentimentrader show how the start to this year compares to the 2013 and 2017 periods (left), as well as one that aggregated the 19 years out of the last 100 with the highest correlation to this year (right). As you can see, after a nice start to the year in the first four months, the market tends to slow over the summer and consolidate before a move higher again, later in the year. Certain indexes such as the Nasdaq and Small Caps have been consolidating for a while now, so we’ll see if this pattern follows and higher prices are ahead.

The earnings picture also continues to provide what should be a fairly sturdy backstop. The more companies that report, the better this earnings season gets. As of Friday, FactSet noted that with 60% of the S&P 500 having reported, 86% had bested earnings per share (EPS) estimates and 78% exceeded revenue estimates. Should it hold, that 86% number would be the best EPS beat rate since FactSet began tracking the metric in 2008. The blended earnings y/y growth rate for the 1st quarter is now an incredible 45.8% (blending those companies that have already reported with estimates for the rest), the highest it’s been since 1Q2010. FactSet also noted that analysts expect double-digit earnings growth in the remaining three quarters of this year, as well, so earnings should be a tailwind if it plays out that way. Given the lackluster performance of the market lately, I thought perhaps the outstanding earnings were already priced in and stocks were being punished for having such a high bar to beat, but that isn’t supported by the data. Again according to FactSet:

“To date, the market is rewarding positive earnings surprises near average levels but punishing negative earnings surprises less than average…Companies that have reported negative earnings surprises for Q1 2021 have seen an average price decrease of -0.6% two days before the earnings release through two days after the earnings. This percentage decrease is much smaller than the 5-year average price decrease of -2.5% during this same window for companies reporting negative earnings surprises.”

So it doesn’t appear that stocks as a group are being sold as a result of earnings, but there have been some high-profile names that have been punished even after beating expectations. Apple, Amazon, Microsoft, Facebook, and Google all were hit hard in the ensuing days after their earnings last week, despite all of them exceeding EPS consensus. Obviously, given how heavily these stocks are weighted, particularly in indices like the NASDAQ 100, we don’t have to look far for why we’re now seeing more weakness show up in the major averages, even though the market as a whole isn’t being sold. Yet, like other more beaten down areas, these heavyweights should now be nearing at least short-term support levels, and if they bounce it could start to improve things fairly quickly. If they don’t bounce, adjustments may need to be made.

Checking in on sentiment, CNN’s Fear & Greed indicator is currently ‘neutral’, which I was surprised to see, expecting to see this indicator closer to ‘greed’. This indicator looks at seven sentiment indicators and how far they've veered from their average relative to how far they normally veer. Each is then looked at on a scale from 0 - 100. The higher the reading, the greedier investors are behaving, and 50 is neutral. The indicators are then combined, equally weighted, for a final index reading.

This is just one temperature-check on the markets and there are several good indicators that highlight investor sentiment, whether it is investor equity exposure, fund flows, cash levels, options trading, or other indicators.

Fed Chairman Jay Powell’s post-FOMC conference (April 28)

There has been much written about the Fed and when they might shift their interest rate policy stance. Every relevant indicator is analysed for insight and the market often will price this change in long before the Fed begins to raise rates. Every indication is that they are in no rush to raise interest rates, and they continue to be very transparent on this point. The Fed is intent on keeping rates at zero and bond purchases intact until it is sure the U.S. can recover all of the 8.4 million jobs still missing due to the Pandemic Recession. The 2008 – 2014 experience still haunts the Fed; it took six years to recover the job losses from the Great Recession. Separately, Powell and the Fed see the current environment as a chance to reset US inflation higher than it’s been in +10 years. The peak was 155.5 million jobs and we currently sit 5.5% below that level. This chart of total US employment levels back to 2005 shows both 1) the history Powell is intent on

avoiding (2008 – 2014) and 2) the progress thus far in recouping employment lost during the pandemic:

The chart shows how long it took the US labor market to recover from the Great Recession, which was just over six years, to get back to the January 2008 peak of 138.4 million employed workers. If one adjusts for 0.7% annual population growth, then the real recovery took until 2016. The current labor market recovery is going faster. Thirteen months from the prior peak, the U.S. has recovered 63% of the jobs lost. After the Great Recession, it took 36 months to recoup the same percentage. The Fed sees its mandate as pulling every policy lever it can to get employment back to 155.5 million people as quickly as possible. Chairman Powell is not interested in unemployment rates and during the Q&A period he did acknowledge that there are many issues out of his control, including many workers who were unemployed 13 months ago who are still reluctant to return to work due to health concerns and others who face childcare challenges with schools not yet fully back to in-person learning. Progress on vaccinations and other virus containment issues will be important to return the US economy and labor markets to pre-pandemic normal and that will take additional time, as the economy looks to heal from the recession of 2020.

Markets at all time highs

While the TSX Composite Index, Dow, S&P, and Nasdaq are at or near all-time highs, it’s noteworthy to point out that that does not mean every sector or company is in the same situation. As indexes are largely cap-weighted (the Dow Jones Index is one exception that is priced weighted), that means often the bigger companies in the index will have an outsized influence on how that benchmark index performs. Many of last year’s top performers have struggled in 2021. Among last years big winners that have seen significant challenges this year include: Virgin Galactic (-67%), Peloton (-49%),

Teladoc (-48%), Zoom (-47%), Snowflake (-46%), DoorDash (-42%), Penn National (-37%), Spotify (-34%) and Roku (-33%). Some of these are newer publicly listed companies. Other big companies that are flat or negative on the year include Apple, Amazon, Costco, Disney, Netflix, ServiceNow, and Tesla. It is worth noting many of these stocks are still sitting on massive gains over the last few years. This is a good reminder that no stock rises in a straight line forever. Stocks will go through periods (which could be months or even longer) and need to consolidate their gains and reset investor expectations. There is nothing necessarily ‘wrong’ with these businesses, but investors have rotated to other sectors and companies that lagged in 2020. While this could continue in the near term, I think it sets up for some of the first half laggards to reaccelerate in the second half of 2021.

Berkshire Hathaway Annual Meeting

Last week, Berkshire Hathaway held its annual meeting in Los Angeles, a change from past years, so that 97-year old Charlie Munger could share the stage and answer questions along with Warren Buffett, Greg Abel, and Ajit Jain. While the meeting may have lost a little sizzle from past years where tens of thousands of investors would attend the weekend festival in Omaha, Nebraska, I certainly enjoyed spending a Saturday afternoon hearing the investing legends patiently answer questions about everything from investing, to ESG (Environment, Social, Governance), to their thoughts on the past year. Well, maybe Mr. Buffett had a little more patience than Mr. Munger….but neither shied away from sharing their thoughts, whether one agrees or not with their views on various topics. The company does not hold quarterly conference calls, so other than media appearances, this is the only time of year to hear from both of them, in an extended format. I find it remarkable, after all the years, that we can continue to hear wisdom from the duo. Not bad for someone who told everyone 52 years ago, he was ready to slow down!

From Marc Rubinstein’s ‘Net Interest’ newsletter:

In the 1950s and 1960s, Warren Buffett ran a hugely successful investment partnership. Just 25 yeas of age at the time, he clawed together $105,000 from six investors and began managing it out of a small study in his rented home, accessible only via the bedroom. His agreement with these early investors was novel: they were guaranteed a return of 4% on their funds; anything above that he would split 50/50 with them, but he would also cover a quarter of any losses out of his pocket. “My obligation to pay back losses was not limited to my capital. It was unlimited.” ¹

Fortunately for Buffett, that loss clause was never triggered – he never had a single down year. In his first few months of operation, he beat the market by 4%, and over the next 12 years he would go on to compound at a rate of 31.6% per year before fees. By the end of 1968, he was managing $105 million on behalf of over 300 investors. His reputation had grown and he had become rich.

And then he wound it all up.

Buffett wrote to his investors in May 1969 to explain. He offered four reasons: opportunities for his style of investing were drying up; his fund had grown too large for small-cap investments to have a real impact; the market had become more speculative as a result of a swelling demand for returns; and finally, “the only way to slow down is to stop”. More than anything else, Warren Buffett wanted to slow down.

Over the next few months, Buffett liquidated his funds, returning to investors a mix of cash and stock in two illiquid holdings over which he had control – Diversified Retail Company Inc and Berkshire Hathaway Inc. He recommended clients reinvest their proceeds in his friend Bill Ruane’s fund or in tax-free bonds. And that was that.

“Some of you are going to ask, ‘What do you plan to do?’ I don’t have an answer to that question. I do know that when I am 60, I should be attempting to achieve different personal goals than those which had priority at age 20.”

We know now of course that Buffett didn’t slow down. Fifty-two years later Mr. Buffett is still at it. Last Saturday he took questions at the Berkshire AGM and on Monday, after years of speculation, he finally announced his successor, Edmonton-born Greg Abel.

Here’s a full recap of the best moments from Warren Buffett at Berkshire Hathaway’s annual meeting: https://www.cnbc.com/2021/05/01/berkshire-hathaway-meeting-live-updates.html