Sell in May and Go Away? Not This Year

As April came to a close, the attention of the financial media turned to the cliche "sell in May and go away". Last night, this the topic on CNBC's OTM. This academic paper attempts to explain the history in terms of year-end optimism that begins in late fall and runs out of steam in the spring. The sell case is made here. The hold case is made here by the Old Prof.

A good review of the seasonality issue is provided by Cumberland Advisors. They argue that the simple analysis leaves out the actions of the Fed and it's impact on the seasonality results.

We have examined this traditional seasonal message with an added dimension. We incorporated a review of the Federal Reserve’s policy actions. We looked at what the Fed did and not what they said. If they raised rates, they were tightening. If they held them unchanged, they were neutral. If they lowered rates, they were easing. We examined the deeds and not the words.

[...]

Our conclusion is that the seasonal factors are not as threatening this year as they are in other years. Fed Funds futures are still suggesting the next Fed policy change is a cut in rates. As long as the market expects the Fed to cut, the pressure on the stock market will be mitigated by an outlook for some relief from present interest rate policy. If that changes, we would then consider the old adage more seriously.

This is a really good read and I recommend the entire thing. I tend to agree with Cumberland's conclusion, but there is a fundamental flaw in their thinking. Cumberland, like most Fed watchers, assumes that the Fed's interest rate actions have the intended results. That is, "[i]f they raised rates, they were tightening. If they held them unchanged, they were neutral. If they lowered rates, they were easing." In reality, manipulation of the Fed Funds Rate is wholly ineffective at managing liquidity or controlling inflation. The Fed's total reserve credit actually grew throughout most of the 24-month rate hike campaign. (More on this in a later post, but here are the numbers for those who want to dig.) Further, the Fed knows that interest rate targeting doesn't work. The cover story of Monetary Trends by the St. Louis Fed tackles it here (.pdf), but this is the money quote:

If long-term real interest rates are determined in a global market, the FOMC’s scope for affecting domestic real longterm yields by adjusting its target for the federal funds rate may be limited.

So while investors would be wise to monitor the Fed's actions in combination with the seasonality effects, they should be careful to monitor the right things. Liquid, market-based signals continue to suggest that the Fed policy is too easy, which as Cumberland points out, means the seasonality issues may not prevail this year.