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Sell In May Is Regime Dependant

Seasonality exists for economic research papers as well. Every spring begins with a variety of papers on "sell in May and go away (or come back in November)."

May has traditionally marked a slowdown in equity markets (with the summer off season considered to be the worst investment period). The evidence for this dates back to 1965.

The US economy was suffering from a strong seasonal pattern with Q2 showing some temporary weakness. There is a huge debate on whether this is due to external shocks (Fukushima, weather) or if it characterized a new feature of the US economy. This is important, given omy regular calls on the short run dependence of S&P 500 returns to the economic cycle. Given the weakening of the news flow (regional PMIs, for instance), the timing for a stock exit (or underweighting) may be near. ISM and NFP data will be of utmost importance.

If history repeats itself, then we will check the statistics. The data used below encompass the 1963-2012 period.

The first table below shows that there should be strong incentive to sell in May: not only is the average return much higher in the November/April period, but the tail risk (negative return) is much higher in the May/October period.

The "sell in May" mantra may be regime-dependent. Its impact on portfolio returns depends on whether the Fed tightens or not, whether the market is in a secular bull (bear) market, and whether inflation is above (below) the Fed's target.

The table below shows that the incentive to sell in May is even bigger when the economy is suffering from excessive inflation.

Since the Fed is not tightening, inflation remains tame, and valuation remains attractive for stocks, we have to go beyond statistics. What could be a trigger for a stock selloff?

Of course bad ISM or NFP readings could be short run triggers.

Yet, for stocks to enter a temporary bear market, valuation should be overstretched, which is not the case.

In addition, the chart below shows that the over-performance of stocks against bonds has dwindled over the last three rebalancing period (see According to this metric (relative performance of stocks and bonds over the short run), there is no strong call for a sharp correction in stocks

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.