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April 29, 2011 8:08 pm

Forget St Leger day – July may be the time to return to market

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The stock market continues to climb a wall of worry. As concerns about economic momentum, monetary policy and inflation mount, equities have continued their slow grind higher. The FTSE 100 has bounced back from its March low and is just 21 points from a new year-high, helped by recent corporate results that have boosted confidence in the global economic recovery.

But will the market now pause for breath? After all, the summer months are traditionally the most difficult for equities. Should investors follow that old stock market saw and “sell in May and go away, come back on St Leger day” – the last classic of the flat racing season in September? Or should they maintain their composure and perhaps adopt a more defensive stance?

It’s well documented that equities have struggled from May to September. Returns from the stock market have been below average and negative in the UK and Europe in this period.

Over the past 30 years, according to Evolution Securities, the average monthly return from the stock market over the summer has been minus 13 basis points in Europe and minus 1 bp in the UK. Looking further back into history, June and May have delivered two of the three worst average monthly returns since 1962. Sandwiched in between them is September.

However, the past couple of years have not been kind to the “sell in May” strategy.

For example, selling in May 2008 was fine but coming back and catching the September to October melt clearly was not. In fact, St Leger day came just days before Lehman Brothers failed. Selling was also fine in 2010 but July was the second-best month of the year while staying out of the market in 2009 meant missing out on a strong July and August and an eventual gain of 21 per cent.

So, based on the past couple of years, investors should have been looking to “sell in May, come back in July, sell again in September and come back in October”. But it’s difficult to see that homily catching on.

Of course, average returns do not tell us the whole story, notes Philip Isherwood of Evolution. UK equities have actually risen in 18 out of the past 30 years in the May to September period but the overall performance is weak because of a few terrible years – namely 1981, 1998, 2001, 2002 and 2008. “This suggests that the success of the ‘sell in May and go away’ is on less firm a footing than a slavish adherence would dictate as it rests on a few key recessionary years.”

Still, there are some strategies that work well over the slow summer months. Defensive stocks such as pharmaceuticals, food retail and utilities have all performed well in the May to September period over the past 30 years, while more cyclical sectors such as travel and leisure, and construction have struggled. This pattern could be repeated this year.

Some strategists have been encouraging clients to take a more defensive stance given their view that the risk reward for equities has started to deteriorate. One is Morgan Stanley’s Graham Secker, who expects equities to remain range-bound over the summer because economic indicators are starting to roll over, monetary policy is turning more restrictive and inflation is on the rise.

As such, he reckons investors should be overweight consumer staples heading into the summer. Not only are they cheap, but they have tended to perform well over the second and third quarter. At the moment, investors are happy to ignore these risks and others such as a Greek debt default. This can be explained by the fact that the global economic recovery remains on track and corporate earnings remain strong. This is important because equities look cheap if forecasts are met – the UK stock market is trading on a prospective price/earnings ratio of about 11.

However, if they don’t – and Mr Secker notes that market earnings revisions have turned negative for the first time since the end of 2009 because of downgrades of financials and cyclicals – the stock market could struggle over the summer. Sell in May and come back for a peak in July, anyone?



neil.hume@ft.com

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