In our mile-a-minute digital society, information is processed in a blink. Conclusions, unfortunately, are sometimes drawn just as rapidly. We've seen an unsettling spate of headlines whose implicit argument is that "Sell in May" must be a myth, given that stocks have not tanked - and May is nearly over! We remind digitally entranced neophytes that the statistically much worse market months of summer lie ahead.
For those hoping to prolong the rally, a summer shakeout - while not essential - would be healthy. But we also see a chance that the recent risk-on rotation could extend the rally well into or even beyond summer and make the "Sell in May" debunkers look like prophets.
The stock market is up more than 4% in May 2013. But May has never been the problem; the idea behind "Sell in May" is to get out of the market at the spring highs and before the summer doldrums. S&P 500 data from across our usual survey period makes this point clearly. We analyzed monthly capital appreciation on the S&P 500 beginning in 1980 and carrying through to the most recent full year of 2012. We looked purely at index price appreciation in the S&P 500, rather than total return.
On the S&P 500, May has averaged 1.09% capital appreciation since 1980. In that respect, since 1980 May performs better than the 0.70% simple average capital appreciation we have measured for each of the 12 individual months. Since 1980, May has posted positive appreciation on the S&P 500 21 times, while declining 12 times. That gives May a 63.6% "win" rate across our survey period. Once again, that beats the simple average win rate for all 12 individual months of 59.9%.
The trouble begins in June. During that first partial summer month, the S&P 500 has posted a positive capital performance 17 times, but it has also declined 15 times. And June has a statistical anomaly in that in three years - 2005, 2006, and 2009 - the change between May month-end and June-month end was a fraction of an S&P 500 point; in those years, the market was up fractionally two times, and down fractionally one time. June has a puny 51.5% win rate, and could easily have done worse but for those two fractional wins. And June has averaged dead flat capital appreciation (actually down three one-thousandths of a percentage point) since 1980.
June's win rate shines next to the July win rate of just 42.4%. Since 1980, 14 Julys have finished in the win column on the S&P 500, while July has been negative 19 times. Counter-intuitively, July has averaged capital appreciation of 0.54% - below the annual average of 0.70% for all months, but decidedly positive. Down July's tend to be mild, while up Julys (like the 7%-plus gains in 2009 and 2010) tend to be outsized.
The win rate in August reverses the July pattern. Since 1980, August has logged 19 wins and 14 losses. That gives August a 57.6% win rate. But on a capital appreciation basis, August like June is fractionally negative. Since 1980, the S&P 500 has on average declined three-tenths of a percentage point in August.
The worst of the bunch is September. The S&P 500 has been up 16 times and down 17 times since 1980 in this partial summer month, for a sub-par 48.5% win rate. But the real problem is performance. The S&P 500 since 1980 has averaged a decline of 0.93% in September. That is not only 163 basis points worse than the 0.70% simple average capital appreciation for the 12 individual months; it is by far the worst single performance for any month in our survey period.
If we average the average performances from June to September, we get about one-tenth of a percentage point of market decline - which counts as four wasted market months. And if we do that same exercise but just since the millennium turn, the S&P 500 actually lose nine-tenths of a percentage point in the June-September span.
If we get a summer sell-off, it likely will not be a bad thing. Since the bull market began in spring 2009, the market has come strongly out of its summer doldrums. 4Q and 1Q, which are usually good market quarters, have been stronger than average since the 2009 bull market began. Corrections serve the worthwhile aims of swamping unworthy names lifted by the bull market's indiscriminate rising tide; they also enable fence-sitters to come into the market at slightly more favorable price points.
Is there a chance this market can dodge the summertime blues? The best chance comes from the current rotation away from defensives and toward cyclical and risk-on categories. For the full year, 1Q13 strength in defensive sectors was so overwhelming that these areas - including consumer staples and healthcare - are still odds-on favorites to win the full year. But the second-quarter swing to risk-on sectors has been notable.
Based on sector SPDRs and ETFs, second-quarter leadership belongs to Consumer Discretionary and Financial Services. Certain risk-on and economically sensitive sectors such as Basic Materials and Information Technology are up in mid-single digits in 2Q13. While that is still not better than the S&P 500's 6.1% quarter to date gain (as of 5/21/13), materials and technology are outpacing consumer staples in 2Q.
We still anticipate a summer sell-off; in fact we would welcome it. For reasons we have stated before - namely, ongoing EPS growth and low valuations relative to bull-market starting multiples - we think this bull market has further to go. Like other summer sell-offs, a 2013 summertime correction would give the bull a kick in the pants for the sprint into year-end.