Sell in May and go away

Not only do we currently face a stock market which is still trading at a 20-year high price-to-earnings ratio (P/E), but we also find ourselves in the month of May. Many warn against the coming winter.

“Beware of the correction,” they say, “Sell in May and go away.” But last year I wrote an article in the 1 May issue on the same topic, and proved that May-sellers haven’t been quite as successful in the past. So what should we do? Should we be worried? 

We all know that markets and share prices alike move up and down. When we look at these trends in Graph 1 over the longer term (and by longer term, I mean decades), however, two very important details become clear: 

• The first is that the general trend is up. Stock markets are trading higher today than they did 10, 20 or 50 years ago. In fact, the market has delivered a return of almost 8% more than domestic inflation over the past 50 years.
• Secondly, it may move upwards, but it isn’t a one-way street and it definitely doesn’t come without potholes. These potholes or drops in market movements are also known as market corrections.  

What is a market correction?

There is no one true definition for a market correction, but between traders, it usually indicates a drop of 10% or more from peak market levels.

In today’s terms, this would mean a drop from our current 54 000 levels down to 48 600 and lower.

Such a massive drop may seem impossible, but the truth is that the FTSE/JSE All Share Index has experienced at least 11 corrections of 10% or more since January 2000.

It may sound like a lot, but the fact is that it isn’t such a strange occurrence at all. Everyone is focusing on the last 12 months’ sideways stock market movements, but few realise that we have already experienced two corrections of 10% or more over the same 12-month period.

Is the market cheap or not?

The market definitely isn’t cheap at the moment and at its current P/E of 21.4 times, it is trading at its highest levels when compared to its 20-year average of 14.8 times (see Graph 2).  

So, sell in May and go away?

I enjoy testing the success of the well-known saying: “Sell in May and go away” with historical data and this year will be no exception. It may have served you well if you had followed this route in May last year, but even this doesn’t guarantee that another correction will follow.

If you managed to do an average-priced sale every May for the past 20 years (20 May months), the markets would have been higher than in May during each December of those years, 70% of the time. So, the Sell-in-May-bears only would have been correct about 30% of the time.

Things become even more interesting when you look at market levels in May in conjunction with high P/E levels.

If you only sold in May over the last 20 years when the historical P/E (FTSE-JSE All Share Index) traded above one standard deviation of its average (in other words, above 17.6 times), you would have been correct 75% of the time, and you would have saved your portfolio an average decline of 9% each time in the process.

The bottom line is that although the market is priced quite high at the moment and the possibility of a correction cannot be excluded, it still pays to not give in to your emotions, and to exercise proper discipline when it comes to your long-term asset allocation. Stay focused on the positive trend over the long term.

*Schalk Louw is a portfolio manager at PSG Wealth.  

This article originally appeared in the 19 May 2016 edition of finweek. Buy and download the magazine here.