Opinions Investor's Corner Sell your stocks in May and go away again
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Investor’s Corner
By John W. Gudritz CFA
Principal
Front Street Investment Management LLC
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In May 2008, I recommended that my readers sell some of their stocks and raise cash. Actually I wanted to recommend that they sell all of their stocks, but I knew that would be extreme. Well, it’s May 2010 and I am very concerned about where the stock market might be headed in the next six-12 months. Therefore, I am once again recommending that investors sell a lot of their stocks in May and focus on protecting those recovery gains over the past year.
As I pointed out in 2008, this old adage of “selling in May and going away” has worked pretty well over the years, but not every year. According to the Stock Trader’s Almanac, the Dow Jones Industrial Average (DJIA) was up on average about 8 percent from November through April in the years 1956 through 2005. However, during those same 50 years the DJIA was only up an average of 0.3 percent from May through October.
This rule doesn’t always work. Those investors who would have followed this adage in 2007 would have been disappointed with the results as the market was up 5 percent in May through October but then fell 10 percent from November 2007 through April 2008. In 2009, the stock market continued to rally from May through October, rising a little over 19 percent (S&P 500 Index). That was definitely worth sticking around for.
As it turned out, this adage worked well in 2008. The optimism that was prevalent in the stock market going into May of that year was soon found to be misplaced as the economic recession got worse and sparked a crisis in the financial industry. The S&P 500 Index fell over 30 percent from May through October of 2008. It was down another 7 percent six months later, but was on its way to a spectacular recovery.
I have not been a fan of this stock market rally over the past year because I believe that the market does not reflect the reality in the economy. I realize that we are in the midst of an economic recovery but if you exclude the massive government stimulus and the very easy monetary policy of the Federal Reserve this economy looks anemic. After almost a year since the economy began to recover, unemployment remains at almost 10 percent, the unemployed and underemployed is stuck at almost 17 percent and personal income growth is growing at less than 2 percent per year.
For those investors who have benefitted from this 70 percent stock market recovery since March 2009, I would take that “gift” from the market gods and raise a lot of cash even though it is not paying much at the moment. I am also not a fan of bonds for new purchases right now, but would be more attracted to them if interest rates rose about a half of a percentage point. Right now I think preservation is more important that seeking out more profits.
As in 2008, the stock market is currently betting on a “normal” economic recovery. Investors have been pleasantly surprised by much better than expected corporate earnings and signs that the consumer is spending again. My concern is that corporate earnings are being boosted by cost cutting more than revenue growth. Going forward, we need to see much stronger revenue growth to achieve those record earnings in 2011 that the market is now discounting.
Consumer spending has beaten my expectations primarily because the savings rate has declined over the past six months. I was wrong. Many consumers did not learn a lesson about spending more than they are making. Despite having little confidence in their financial future (according to the Conference Board Survey), they obviously could not resist those tempting incentives that the government created to sell more cars, houses, and even appliances. And with the warmer spring weather, who can resist buying some new summer clothes?
Investors no longer believe that the economy could slip back into a recession over the next 12 months. I think that position is premature. Over the next year the economy will not have the wind at its back with all of the government stimulus spending. Unemployment insurance benefits are coming to an end. There are now 11 million people receiving these benefits. Over the next few months 1 million folks will no longer receive that $320 a week benefit. That is a total annual loss of $16 billion in income for those people and our economy.
In addition to that headwind, income taxes will be going up in 2011 for those individuals and couples making over $200,000 or $250,000, respectively. While they may represent less than 5 percent of the population in the U.S., they earn about 30 percent of all personal income. Investors will see the tax rates on dividends and long-term capital gains rise too. These increases in taxes and also regulations will reduce economic growth in 2011 and beyond. This is not something the stock market is currently concerned about but it should be, in my opinion.