‘Sell in May and go away’ advises the old adage, based on the historical underperformance of equity markets between May and October compared to November to April.
The recent sell-off in global fixed-income markets and decline in global equities has many asking if there is something in the saying after all. But trying to time the markets is never a great investment strategy. Market volatility over the coming months may look more like the last couple of weeks than the last couple of years, but these market dips could present a buying opportunity rather than a reason to avoid the market.
Investors are becoming increasingly sensitive to valuations and Janet Yellen, head of the US Federal Reserve, brought home the point the other week when she responded to a question on markets with “…equity valuations at this point generally are quite high.” However, it is important to view this in the context of what came next: “…they’re not so high when you compare the returns on equities to the returns on safe assets like bonds…”.
Equity valuations should be measured against the value of other assets and against our position in the business cycle. Valuations on a forward price-to-earnings metric are certainly above average, but they are not extreme.
Parallels are being drawn between Ms Yellen’s statement and that of former Fed chairman Alan Greenspan back in 5 December 1996. After Mr Greenspan’s warnings over “irrational exuberance”, the S&P 500 rose 106 per cent over the following three years until the tech bubble popped. So should we heed Ms Yellen’s warnings this time around?
It is not just US equities that are no longer cheap; valuations in developed equity markets around the world have moved above long-run averages. In Europe, it is the speed of the rally in equities that is stirring up nerves and increasing the chance of a shock as it would for any asset class. The German and French markets have gained 16 per cent so far this year, while the Italian market is up 22 per cent. Based on these levels and valuations, investors should expect less, rather than expecting a loss, and should maintain that tilt towards risk assets.
Since 1926, there have been 10 bear markets – in other words, corrections of more than 20 per cent – in the S&P 500. In nine out of 10 of those bear markets, one or more of the following factors were a cause: a recession, a negative commodity shock such as a sharp rise in the oil price, aggressive monetary policy tightening, and extremely high valuations. None of these factors is in play at the moment. In fact, eight out of the 10 bear markets corresponded with a recession, and, if anything, the global economy is strengthening rather than slowing.
We may be in a period of consolidation in equity markets and volatility will no doubt increase over the summer, but the fundamental pillars that support equity markets have not changed. The weak euro, low oil price and improving economic outlook will back European equities. These same factors – low oil and strong dollar – have been a hindrance to the US market, but that may also change. The dollar’s rapid ascent has abated and the US dollar index has fallen by close to 5 per cent since this year’s peak back in March. Meanwhile, the oil price has risen by 33 per cent since the market low, providing a reprieve for the energy sector.
