ASX in May

During this time, the average move in the ASX 200 (during May) has been a 2% decline and some 50 basis points (or 0.5ppt) worse than any other month. This is not to say that this year will keep up the tradition of the ‘sell in May and go away’ phenomenon but as traders we are always looking at increasing probability where we can.

In 2014 for example, things weren’t too bad and we saw the index actually close up a modest 0.1%. However, the four years prior saw the ASX 200 record a loss of 5.7% on average. Tax loss selling could partially explain the falls, especially with the materials and energy sectors getting sold off aggressively in the lead up to May and investors sitting on some big losses in this space. The other factors that I feel influenced price action in previous Mays have been fairly specific to that period and the fact that May has traditionally been a weak month could be merely coincidence.

Will we see the ‘sell in May and go away’ phenomenon materialise this year? Naturally, we don't know but we can look at the various factors that increase probability. To assess this, one naturally needs to take a look at the upcoming event risk (both at a macro and corporate level). But it’s also important to look at valuation, market internals and the technical set-up.

Fundamentally, the ASX 200 trades on 17.5 times consensus forward earnings, which is a 15% premium to the 20-year average. This is very much in fitting with other developed markets where investors are struggling to find real value. Interestingly, the current consensus forward earnings multiple is in-line (around one standard deviation above the long-term average) with the P/E multiple seen at the all-time high in 2007, as well as 2009.

In both 2007 and 2009, the elevated valuations in the ASX 200 subsequently coincided with heavy losses on both occasions. This doesn’t mean we will necessarily see similar moves again but it does suggest the upside will be harder to come by unless we see earnings growth.

On this point of earnings, it is also worthy of note that analysts’ consensus earnings have been revised lower by around 7% since July 2014, which of course has been a major catalyst behind the P/E multiple expansion. The negative earnings revisions are thematic with other developed markets such as the US, although there are some improving trends in Europe and Japan which are a key reason behind the outperformance of these markets in Q1.

The bulls will point to the aggregate dividend yield which has been an important attraction for investors and even after the market’s bullish move to the 6,000 level, still commands a 4 handle. The market is placing a 53% probability of the Reserve Bank acting on its easing bias at the 5 May meeting, which only re-enforces the index yield, especially when compared to term deposits or government bonds.

So valuation seems stretched, although there continues to be yield support. Things are looking a touch shaky if we view some of the market internals. The corporate participation on the move higher since 22 April has waned of late and, as things stand, some 58% of companies are trading above their 50-day moving average. Compare this to the previous test of 6,000 in February and March, where we saw 83% and 64% of companies above the medium-term average. A similar pattern is seen in the shorter-term 20-day average, but both could be seen as a bearish sign that we are not seeing such broad based participation in stocks when the index tries to make a new high. Market breadth is important when assessing the quality of the rally and, as things stand, breadth is falling and we are generally seeing stocks with big index weightings pushing up the ASX 200.

Technically, if we look at the weekly chart, the index is consolidating within a longer-term bull market and a weekly close through 6,000 would suggest a move towards the 6,200 level. The daily chart is also fairly bullish, although the RSI is showing signs of divergence, with prices making new highs and the RSI a lower high. Divergence can often lead to powerful reversals but we will need to see price make a lower high to confirm the move. The trend seems to be fairly positive at present and pullbacks look like buying opportunities if we look at the market on a longer-term timeframe.

So, all-in-all, we know May is traditionally the worst month to be long Aussie stocks and with valuations at levels historically thematic of sharp sell-offs and market internals a touch shaky this could materialise again. However, the technical picture is not giving any clear sell signal right now and this to me is the key. A combination of weak technicals and elevated fundamentals will be a strong red flag to the bears. However, it seems we are not quite there yet but this could still change. May promises to be very interesting.

 

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