Seasonality

Author: David Kotok, Post Date: April 24, 2007
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“Sell in May and go away” says the old Wall St. adage.  “Should you obey?” asks Paul Lim in his New York Times column (Pg. 5, Sunday Money Section, April 22, 2007).

Paul Lim noted how the S & P 500 averaged a meager 1.6% for all the May-October periods since 1945.  And he also noted how the average for the other part of the year was an impressive 7.1%. 

The broad statistics about summer seasonal market weakness argue for selling.   The case becomes even more compelling when you add to those numbers the fact that the worst market months of September and October are included within that half year period.  On the other hand, the traditionally strong summer rally months of July and August are a mitigating factor.   So where does that leave us?

We have examined this traditional seasonal message with an added dimension.  We incorporated a review of the Federal Reserve’s policy actions.  We looked at what the Fed did and not what they said.  If they raised rates, they were tightening.  If they held them unchanged, they were neutral.  If they lowered rates, they were easing.   We examined the deeds and not the words.   

The Fed’s actions alter the old adage.  New rules should read that if the Fed is tightening, you should sell in May and run for the hills.   The weak May-October seasonal period has been particularly painful for stock investors when the Fed was raising rates.

When the Fed is easing in the summer seasonal period, you can ignore the negative seasonality.  Other factors may influence the markets in either direction but an easing Fed seems to remove any negative influence that would cause you to “sell in May.”

What about a neutral Fed.  That is what we currently seem to face?   Here the history is mixed which means there is no compelling case in either direction.  But there is one small factor to consider.

During most of the post World War Two period, the intentions of the Fed were mysterious and opaque.  Often the Fed’s policy changes were not discerned until transactions were observed by “Fed Watchers.”  The Fed did not issue guidance nor did they stress transparency.   That has become different in the Greenspan-Bernanke era. 

Also different is the development of an active Fed Funds futures market.  This element is offering a market based pricing of the market’s expectation for the Federal Funds Rate, the instrument of Federal Reserve policy.  Thus we have to alter the seasonal rules again.

We would now say to “sell in May” if the Fed Funds futures market was demonstrating an expectation that the Fed was going to hike in the future.  This is currently not the case. 

We would put some weight on the Fed’s statement but only some.  We are much more influenced by the market’s pricing mechanism, where investors are betting real money on an outcome, than we are by the words emanating from the FOMC after each meeting.

Our conclusion is that the seasonal factors are not as threatening this year as they are in other years.   Fed Funds futures are still suggesting the next Fed policy change is a cut in rates.  As long as the market expects the Fed to cut, the pressure on the stock market will be mitigated by an outlook for some relief from present interest rate policy.  If that changes, we would then consider the old adage more seriously.

Cumberland’s accounts are fully invested worldwide using exchange-traded funds (ETF).  Our bond accounts are targeted on a neutral duration to their benchmarks.  We are still over weighted the energy sector and are going into our fourth year in that mode.  It is not too late to add an energy position if you haven’t already filled your appetite.   

We are very nervous about the world’s geopolitical situation.  Recent events in Pakistan, Nigeria, Ethiopia and the Middle East only intensify that concern.  The geopolitical situation today does not suggest immediate selling but it does suggest heightened vigilance.  We are constantly on alert for any event which would cause us to raise cash and change strategy. 

Sadly we must note that there seems to be an oppressive and murderous element at work in the world.  This is true in a university here as it is in the Shia-Sunni civil war in Iraq and elsewhere.  We wonder if the 21st century has added a component that has more reverence for death than for life.  Such is the profound question of our times.  Dealing with this threat is the dominant challenge for those of us who enjoy the great freedoms of the United States and the western world.

 

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