The "sell in May and go away" scenario could present itself this year. The markets have been on fire thus far in 2013. The SPDR S&P 500 (SPY) is up over 10.5% year-to-date. That's approximately a year's worth of gains in less than four months. Since the stocks comprising the index are expected to earn an average of about 10.5% annually, this should approximately equal the yearly gains for the index. Since markets don't continue to rise without corrections, it is possible that we'll see a dip soon.
Historically, since 1950, the Dow Jones Industrial Average (DIA) only gained an average of 0.3% from May through October. The Dow gained an average of 7.5% from November through April since 1950. There is no doubt that a dip in the market is due. I wanted to explore the possible causes that could trigger this scenario for 2013.
A barrage of disappointing earnings reports could trigger a sell-off in the market. Revenues and earnings that miss targets could spark fears that an economic slowdown is on the horizon. Overall, many companies have been improving since the financial crisis, but if earnings reports suggest an overall decline in fundamentals, the market could reverse course.
Poor economic reports could also spark a correction in the markets. The infamous jobs report (non-farm payrolls) reported on May 3 could come in significantly lower than expected. This could bring fears of an economic slowdown on Main Street that could lead to a dip on Wall Street. Worse than expected figures for other economic indicators such as consumer confidence, construction, manufacturing, CPI, etc. could lead to a sell-off in the stock market.
The European debt crisis could resurface and trigger turmoil in the financial markets. Confidence in the euro zone's economy fell for the second straight month in April. The Economic Sentiment Indicator for the 17-country Euro zone fell 1.5 percentage points to 88.6. This was worse than the expected figure of 89.3. Europe is trying to climb out of its recession that has plagued the region with record unemployment levels. The problems in this sensitive region tend to resurface.
Another possibility to trigger a sell-off could be a large unexpected event such as an earthquake, a new war, another major oil spill or similar disaster, etc. Such an event would have to be perceived as significantly upsetting to the normal course of business.
What Investors Should Do
Investors would be wise to keep a long-term view and continue dollar-cost averaging into a diverse mix of stocks and bonds appropriate for one's age, or years until retirement. Trying to time the market on events that may or may not happen can lead to significant losses. Even if we do get a correction, dollar cost averaging allows investors to purchase stocks at lower prices.
Those who want protection just in case a sell-off occurs could consider buying put options on SPY. Volatility is low, thus providing investors with relatively cheap put options. This could be considered an insurance policy for one's portfolio.