We have reached the point in time when investors must ask themselves if the old adage "Sell in May and go away" is worth following. For the past three years in a row, selling in May and going away, has been a very good move. For many investors and fund managers, cashing in now by taking profits on the very strong gains makes sense from a seasonal and business standpoint.
If you manage money and have already made gains in the first few months that would be on par with what is considered as respectable returns for an entire year, why would you risk that (and your bonus) by holding out for more? Also, many fund managers and investors are prone to selling in May because this allows them to take some time off and go on Summer vacation without the stress that comes with staying fully invested. The S&P 500 Index (NYSEARCA:SPY) is already up by about 10% for 2013, and this follows up gains of about 15% for 2012. This index and many individual stocks appear extended now and are trading well above key support levels. This is another reason why selling in May could make sense. Take a look at the chart below and it is clear to see how extended this market has become.
Another reason to sell in May is because this rally is not organic and therefore not high quality. This rally is government-induced as artificially low interest rates, and asset buying from the Federal Reserve serves to prop up an economy that is still lacking in demand from many areas. That is why this rally has not been respected, or trusted by many investors. At some point, the Federal Reserve will need to pullback and that could lead to a significant decline in the stock market. A number of major industrial companies have reported disappointing first-quarter earnings as well as weak top-line growth, which indicates underlying weakness in the economy. Just take a look at the charts of companies like General Electric (NYSE:GE) or Caterpillar (NYSE:CAT), which have seriously lagged this market rally and it is easy to see why investors should be concerned. In a real and organic economic recovery, industrial stocks like these should be leading the market, not dropping.
Another troubling factor that should not be ignored is the significant weakness that many commodities have experienced. Take a look at copper, aluminum, iron ore, coal, steel and other basic commodities. It is rather alarming as to what these price declines could be forecasting for the economy. In an organic and sustainable economic recovery, a company like U.S. Steel (NYSE:X) should be trading with strength as investors would want to get in before the economy fully recovers. Instead we have investors piling into consumer staples, which is a fear trade based on the fact that investors might stop buying durables, but will keep on eating cereal. When "Dr. Copper" is sick as Dennis Gartman points out, and cereal stocks from General Mills (NYSE:GIS) to Kellogg (NYSE:K) are booming, we've got a problem. The charts below say it all, and it is not a good sign in regards to where this economy could be heading.
There is too much bear versus bull debate and it's true that bears have been wrong so far this year, but that could change. To simply say that bears have been wrong and therefore it makes sense to stay fully invested is silly. Let's remember that bears have been right about selling in May for the past three years. I think the real question investors should be asking is "what do I have to lose by selling in May?" I believe the answer is very little. How much more can investors truly expect to gain by staying fully invested for the next couple of months? Is the market really likely to make another major move from current levels? I doubt it, so maybe the upside is another 1 or 2%, if things go very well in the next couple of months. Why not take at least some profits, and relax on the beach worry-free. Even if it means you could miss another 1 or 2% in gains, it makes sense since the market could easily drop 5% or more if things don't go well.
Given this analysis, the risk-to-reward ratio indicates it could be smart to take at least some profits. The potential gains for staying fully invested look minimal after the run this rally has enjoyed, especially when considering there are many warning signs about the health of the economy. That's why there is probably not much to lose, and possibly plenty to gain by selling in May.
Data sourced from Yahoo Finance. No guarantees or representations are made.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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