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ADV PART II
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Market Commentary

Sell in May and Go Away?  Or Stay?
May 12, 2010, David Kotok, Chairman and Chief Investment Officer

There is plenty of historical evidence to suggest that the period from May through October is the weakest half of the year for stock-market investors.  Studies of markets worldwide have confirmed that phenomenon: November through April has often outperformed the May through October period by a large margin. 

We examined the history of stock-market performance for the May-October period in order to determine the reasons for the discrepancy.  We specifically focused on the actions of the Federal Reserve.  We looked at what they did and not at what they said.  If they raised the Fed Funds rate, we considered them to be tightening.  If they kept the Fed Funds rate the same, they were neutral; and if they lowered the rate, they were easing. 

When the Fed is tightening during the May-October period, American stock-market investors are best served by selling in May and going away.  A hostile Fed can really damage portfolio values between May and October.

When the Fed is neutral, the May-October period still underperforms the November-April period.  A neutral Fed neither helps stock-market investors nor hurts them.  Other seasonal factors seem to contribute to the difficulty of the May-October period. 

When the Fed is easing between May-October, monetary policy fully neutralizes the negative seasonal effects.  An easing Fed allows American investors to ignore the “sell in May and go away” cliché. 

So, what do we do in 2010?

The Fed is unlikely to raise the targeted Fed Funds rate between May and October this year.  They cannot lower it, since it currently is between zero and a quarter of one percent.  Therefore, the application of the results of our historical study is hampered by the existence of the zero-interest-rate lower boundary.  For this reason, we have to assume the Fed is either neutral or easing, and cannot be sure which applies.  We have no history to guide us. 

The same logic applies to other markets of the world.  When we survey central banks, we find that Japan is unlikely to raise its targeted policy interest rate.  It is currently near zero.  The UK is also unlikely to raise its policy interest rate.  In Europe, we are witnessing a massive easing of credit as the European Central Bank and the European Union create their version of a crisis response. Their policy may be likened to our American TARP and Federal Reserve activities following the failure of Lehman Brothers. 

The Federal Reserve’s expansion of international swap lines appears to us to be a form of easing.  Granted, it comes in response to the European crisis and the ECB initiative.  However, easing is easing, no matter what form it takes. 

As a result, we enter the May-October period with the working assumption that the G4 central banks are collectively easing.  This should neutralize the negative seasonals in 2010.  That is bullish for stock prices. 

Our portfolios are again nearly fully invested.  We have redeployed the cash raised from mid-April forward.  We are glad we raised it.  The sell-off in stocks gave us a chance to spend it, and we did.

We expect stock markets to trend higher.  Our target for the US market remains 1250 to 1300 on the S&P 500 Index.  We believe the US stock market will fully close the “Lehman gap.” 

David Kotok, Chairman and Chief Investment Officer
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