Now that the Federal Reserve meeting has shown that the world’s most powerful central bank is looking to reduce the pace of asset purchases, will the coming weeks see further losses for already embattled equity markets?
The spring swoon
In each of the past three years, investment bank JP Morgan’s global PMI (purchasing managers’ index) has recorded global economic data as weakening after the burst of activity in the first quarter faded. The effect has been most marked in the US economy, which remains the economic powerhouse of the world. Retail sales, manufacturing indices and job data all faltered, and while this boosted expectations of further easing from the Fed, investors still reacted by reducing their allocation to risk.
Economic data in May remained reasonably strong, but the HSBC China manufacturing index out this morning showed that we are experiencing difficulties in many parts of the global economy. Combined with an apparent change in policy at the Fed, the previous conducive environment for stock markets seems to have come to an end for now.
'Sell in May' delayed?
‘Sell in May, go away, and don’t come back until St Leger’s Day’ is a long-established stock market axiom. One study from New Zealand was even able to identify seasonal weakness in the British stock market going back to 1694. Data for the Dow Jones industrial average shows this seasonal weakness even more clearly. The average return for the May-September period was only around 0.3%, compared to a return for the October-April period of 7.5%. Such a remarkable disparity does mean that the ‘Sell in May’ effect cannot be ignored.
Looking back at May 2013, we can see that investors who sold would have been rather early to the party. Now, however, the timing seems rather more prescient. Bernanke may not have taken away the punchbowl, but he has given notice that he does not expect to be filling it up again any time soon. Many assets have given back most of the gains they made so far this year, while others are breaking into new lows.
In times such as these, flexibility is a must for investors. Even if an investor intends to ride out the summer period, he must be prepared to see increased volatility and sustained moves in the wrong direction. There is the case to be made that judicious shorting, with careful risk management, can help investors recover some of the losses they might see over the summer.