Sell in May and go away?

This saying has been used as a catchy headline ever since I first entered the market back in 1980. I don’t know if many people actually heed this advice but I thought it was a topical subject to kick off this month’s article.

Statistically, the six-month period starting in November and ending in April tends to outperform the alternative period from May to October. There are a few reasons for this, including the northern hemisphere summer vacation that sees investors, companies and bankers alike, taking holidays. The beginning of the calendar year typically sees asset allocation decisions being made, which often leads to increased buying of stocks and the (seemingly) irrational Christmas rally, fuelled, perhaps, by a few too many Christmas parties and accompanying beverages.

Supporting this theory, last year the market was flat between May and November, before launching into a strong rally that took it from about 4,500 to 5,150 in March and around 4,960 now.

How will it play out over the next six months? Let’s consider the major factors that we are aware of. It’s important to understand that, more often than not, it will be something that we don’t anticipate that has a surprising impact on the market, but let’s look at some of the big drivers we can identify.

Japanese turbo charged QE

The Japanese are famous for their high performance, turbo charged sports cars and now they have taken the same approach to trying to get their economy growing, and defeat the deflation that has plagued the economy and investors for about 20 years since the boom ended back in the early 1990s.

The Bank of Japan (BOJ) is pursuing money printing and bond buying at twice the rate of the US Fed. Consequently, the yen has collapsed and capital has flowed out of Japan, chasing alternative yield opportunities.

Australian markets have been beneficiaries of these outflows, which are likely to continue. The collapsing yen is probably a net slight negative for our export-orientated industries but a positive for consumer spending and import companies. The Chinese exported deflation to the world for the last decade or so and now the Japanese will have a go. How cheap will that new Toyota get? Could this be a final nail in the coffin of the Australian car industry?

Unfortunately, the BOJ is fighting against the sad reality of an ageing population, an already efficient workforce and a zero immigration policy. Real economic growth in such an environment will be a challenge.

The gamble the BOJ is taking with this latest effort to turn its economy around has a familiar air of desperation to it.

A Gillard guillotine?

In September we will have another federal election (and not a moment too soon I hear many of you sigh). Both consumers and stock markets tend to go quiet ahead of major elections. Uncertainty always seems to have an impact on behaviour, even if it’s subconscious. The very early calling of the election by the PM has provided a long lead-time to subdue sentiment. While consumer spending recovered late last year and into this year, in recent months it has softened, and we would expect things to remain this way until the election is out of the way.

Not so super changes

The proposed taxation changes relating to self managed super funds are set to make money for Governments and accountants. Not only will taxation get even more complex (if that’s possible), but active tax planning within SMSFs will become common place in order to massage earnings under the tax threshold.

Unfortunately the Federal Government has a massive fiscal black hole and whichever party is in power, taxes will go up. Tony Abbott has not said he will fight against this new tax, he has just publicly condemned it.

One of the elements of the proposed changes is that stocks held in super funds (before early 5 April 2013) will be grandfathered and effectively exempt from contributing to income via capital gains. This will provide a strong incentive to hold these stocks and not to sell. This should have a slight positive influence on stocks, as owners will be less inclined to sell.

We saw a similar phenomenon in the 1980s with the CGT exemption that was provided to stocks purchased before the 1985 cut-off date when the CGT was introduced.

Miner’s massacre

For anyone following the mining sector, you would probably have noticed that the market boom in miners came to a shuddering end, with the small miners index falling over 40% in the last year, and much more from previous highs. BHP and RIO have been relatively strong performers and are only down slightly over the period.

Sentiment is so negative and short positions are so high that our sentiment intelligence tells us the bottom is close. However we tend to avoid mining stocks.

At Wilson Asset Management (WAM), we endeavour to invest in companies that we anticipate will deliver healthy earnings per share growth. It’s a pretty simple goal really! What makes up earnings per share?

1. Costs

Reasonably easy to anticipate for most businesses unless they have a high raw material input of a volatile commodity.

2. Volume

More difficult, but often reasonably easy to predict if a business has an existing track record of profitable activity. Volume is made up of the number of units sold.

3. Price

This is the big one. In many industries, price can be anticipated due to market conditions, business history etc. In the case of miners, one needs to develop an expertise in commodity pricing. If you don’t have a strong view on the underling commodity prices, then you can’t calculate earnings. This is why we (generally) avoid this space. However, if sentiment gets to a point where stocks are insanely cheap (selling at big discounts to cash) we may find value that is adequately compelling.

I should add that small miners that are yet to deliver a real business case with a commercially viable resource, are nothing more than gambling tokens. They are attractive to many because, for a small investment, a large upside potential is delivered. We call it the “Tatts Lotto effect” and it attracts many to its seductive swoons but we like to invest when the odds are in our favour. We don’t believe that is the case when investing in small mining stocks.

US recovery ongoing

The US recovery continues to limp along and create jobs while asset prices keep going up. The US stock market is still hitting all time highs, being fuelled by the Fed’s printing of US dollars, a slow consumer recovery and a weak US dollar helping exporters.

Given the significant rally, the US market has experienced over the last year, a respite over the next six months would not surprise me at all.

So… sell in May?

Time will tell. But perhaps the words of the great Mark Twain may be useful;

“October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.”

Mark Twain obviously missed out on creating significant wealth through investing in the stock market.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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