By Michael McCarthy

Sell in May and go away? Many investors are asking this question at the moment. I’m no fan of observing old market sayings as an investment approach, despite the fact that this one is supported by the numbers. However technical, fundamental and possibly political factors currently agree with this old market saying.

Fundamentals

The recent run up in share prices has pushed the main Australia 200 index to levels where some consider it expensive. In rough terms, the index Price/Earnings (P/E) ratio’s “normal” range is 12x to 20x.

Below 12x may be considered cheap, and above 20x, expensive. There is an argument that P/E ratios should be higher than average in a low interest rate, highly liquid environment. Nevertheless, at around 22x the Australia 200 index is on the expensive side of the balance. This is offset somewhat by a dividend yield around 4.75% (plus franking).

Given last week’s shockingly low inflation read, risks to the growth outlook could be on the downside. Recent bank reports show weak loan book growth, and rising bad and doubtful debts for 2 out of 3 lenders. In other words, the index is trading at higher levels as fundamental risks are rising.

Political Influence

The usual advice to investment writers is to stay away from politics – you’re bound to offend at least half your audience. However, the election campaign is now official. Most campaigns are relatively market benign, but this time there are a number of hot button issues that could affect the market. 

Importantly, with financial stocks comprising half the value of the market, flagged changes to negative gearing and superannuation rules, and possibly a banking royal commission, means there is real potential for market moving policy announcements. Unfortunately, most are in the negative category.

By the Numbers

Studies in the US and in Australia confirm there is a seasonal bias to markets. Statistically speaking, the period from November to April outperforms the period from May to October. There are many theories around this idea, but few satisfactorily explain the observed facts. The puzzle is deepened by the simultaneous occurrence in both the US and Australia, seeming to rule out the seasons or the financial year. 

The trouble with seasonal factors is that they don’t appear every year. If investors are sure they will sell in May each year, there is a statistical basis to the behaviour. But selling in any one year is more fraught – this may be one of the two years in ten where the market underperforms. This is the main reason I avoid a seasonal approach to markets – I don’t want to lock in to a strategy that requires me to act each year in the same way.

Having typed that, this may be the year to sell. The charts are strongly aligned with “sell in May” tactics:

 

In broad terms, the Australian share market is trading sideways. The range is defined by the highs and lows since August last year. At some stage, the market will burst through one end of the range, but given the mixed outlook, in my view it’s more likely to gyrate with market sentiment for some time to come.

Every investor’s situation is different, and there is no single right answer in the investment space. One rational response to a sideways market that may not deliver sustained capital gains is to take a more active approach, picking stocks and acting when the market swings – selling rallies and buying dips. Looking at the political, economic and technical factors, those pursuing an active strategy are likely weighing up selling right now.