By Eleftherias Kourtalis
The resilience that markets have shown, despite the jitters caused by the March banking shocks, may be tested next time. The question that worries the investment community every year around this time is whether the stock market saying “Sell in May and go” will come true. The phrase refers to a stock strategy based on the theory that the market underperforms the six-month period between May and October (the saying goes “…and comes back on Saint Leger’s Day” which is late of September).
Statistically, the amounts invested in the markets from November to April tend to exceed the amounts invested from May to October, while corrections tend to be larger during the selling periods in May. As Bank of America analysts point out, seasonality since 1928 shows that May through October has the lowest average returns of any six-month period of the year, with the S&P 500 rising 65% of the time for an average return of 2 .16%.
However, the Sell in May strategy does not always work. By contrast, the stay-in-market strategy has outperformed the US market in recent years, for example. “Average returns over the six-month period are not negative and while May can be a weak month if someone sells in May and exits the market, you could miss out on a summer rally,” BofA adds.
And historically, there are many periods where Selling in May didn’t work out and markets rallied. 2020 and 2021 were examples where massive Federal Reserve interventions pushed prices higher in April and the following summer months. However, the opposite was true in 2022, as markets fell sharply in April as the Fed began an aggressive rate-hike campaign the previous month.
As April comes to a close, the question is: will 2023 be another year where the “Sell in May” strategy works or not? While no one knows the answer, historical statistics, current economic indicators, and technical measures suggest that some caution is warranted. After all, the international investment houses in their new reports on the course of the markets express caution and emphasize that the rally does not have much room to continue in the next period.
JP Morgan: The “bottom” of the markets has not yet been marked
The first quarter earnings season started with some positive surprises and there may be more to come. But that shouldn’t be dismissed as a sign of better stock performance, according to JPMorgan analysts. It was easy for companies to beat low earnings expectations, while the numbers were also boosted by economic activity that was better than in the first quarter of 2022, analysts said.
“The question is whether shares will rise further on the back of these results,” analysts at the US bank said. “We recommend that you use any strength from the positive first quarter results as a good level to reduce your positions,” they add.
To be bullish on stocks at this stage, one needs to have a very bullish set of assumptions about growth/rates/China/politics etc., JP Morgan notes. All of this contributes to his view that stocks will weaken for the rest of the year. JPM was bullish on the stock in Q4 2022 and we expected the lead to extend into Q1 2023, and believes the wisest strategy is to be underweight going forward.
JPM continues to believe that we have already seen market highs for this year and emphasizes that the strong rally that began in October, which was driven by peak inflation estimates, China’s reopening and falling energy prices in Europe, is not has reason to “exist” in the second half of 2023.
“At the beginning of the year, the markets continued to have a supportive and resilient economic environment on their side, but now all support has ‘expired’,” he says. We recommend that you use them as an opportunity to continue liquidating. their positions”, emphasizes JP Morgan. “It is unlikely that we will see the bottom of the markets before the Fed has already changed its stance and made interest rate cuts”, he emphasizes.
Citi: Watch out for falling profitability
Citi economists expect the US to enter a recession in the fourth quarter of 2023. Even if European GDP exceeds that of the US, European stocks and the profitability of European companies will come under pressure, he says. While the worst of the recent banking turmoil is probably behind us, it still forecasts subdued global growth, with further risks of ultra-low growth. Even in the positive scenario, the US will go into recession and this will have a significant negative impact on global stocks, with Europe at the center, he acknowledges.
Even if US and European GDP don’t move at the same pace, earnings per share (EPS) of publicly traded companies may, Citi notes. European companies have become more international, and profits are increasingly correlated with those of US companies. In particular, a quarter of the revenue of European companies now comes from North America, with some industries reaching up to 50%.
In the last three decades, Europe has never avoided an EPS contraction around a US EPS recession. And more specifically, Citi finds that during a quarterly contraction in US EPS, there is a 70 % chance that the European market will also experience a decline in EPS in the exact same quarter. Simply put, Europe will fight to avoid being hit by a US earnings-per-share contraction, as Citi points out.
So Citi still prefers US stocks to European ones. As he points out, the US tends to be more defensive than other markets during earnings slowdowns, with the S&P 500 outperforming the Stoxx 600 in each of the last six major US EPS declines. was a key reason behind Citi’s recent upgrade of the US stock market to overweight and Europe’s downgrade to neutral.
SocGen: limited room for market upside
The European stock market has fully recovered from the March sell-off and is now trading even higher than it was in February, Société Générale notes. However, if we look at the European market, it seems that the rise is due to defensive rather than cyclical stocks. Since the beginning of February, low beta sectors have generally outperformed high beta sectors, despite the fact that the market is slightly bullish. A bull market led by defensive stocks is nothing new, having happened about ten times in the last decade, but this is the first time since early 2020, just before COVID.
What does this mean; SocGen emphasizes that the outperformance of defensive stocks and sectors is essentially a reflection of investors’ lack of confidence in the current business cycle and the outlook for the economy. The market has probably already priced in too much good news (opening of China, no power outages in Europe, etc.).
While SocGen in the second half of 2022 and early 2023 recommended positions in cyclical stocks, in mid-February it changed its stance, reducing its exposure to these assets. At the time, their models showed that after cyclical stocks outperformed between June 2022 and February 2023, markets no longer priced in a contraction in the economy and valuations between cyclical and defensive stocks had normalized. The recent underperformance of cyclical stocks has not changed the overall valuation picture, and the new Eurozone manufacturing PMI data (at 45.5) is not an incentive to rush into cyclical sectors.
Based on the foregoing, the French bank highlights that it does not see significant increases in the entire European market until the end of 2023, because the market is highly valued and it does not expect the profitability of companies in 2023 to increase. However, he sees some investment opportunities in “value” stocks in Europe, which have been left behind and may benefit from higher interest rates and a resilient macroeconomic environment.
BofA: “Sees” a fall in Europe at the beginning of the fourth quarter
Bank of America maintains its negative stance on European equities and maintains an underweight recommendation on cyclicals vs. defensives. “Our expectation of weaker growth and a widening of risk premiums is consistent with a 20% drop in the Stoxx 600 to 365 points at the beginning of the fourth quarter,” emphasizes the US bank. His macro forecasts, he adds, are also consistent with sub-10% returns for cyclical stocks versus defensive stocks and value stocks versus growth stocks. His favorite defensive sectors are food and beverage and pharmaceuticals, while large underweights are banks and autos.
The recent BofA fund manager survey shows that most investors are now bearish on European stocks. In particular, 70% of investors expect a bearish trend for the European market in the coming months in response to monetary tightening, and 55% expect a decline in the next twelve months. Persistent inflation leading to further central bank tightening is seen as the most likely cause of a correction (30% of respondents), followed by weakening macroeconomic data (25%). 38% see a lack of defensive hedging strategies as the main risk to their portfolio, although 25% worry that reducing their equity exposure too much could miss out on a continuation of the rally.
At the same time, 75% of fund managers believe that growth in Europe will weaken over the next 12 months in response to monetary tightening, while 55-60% expect a recession. Globally, 63% predict a slowdown in the next twelve months, and 48% anticipate a recession in the global economy.
In addition, 58% expect falling demand in response to worsening credit conditions to be the dominant macroeconomic theme in the coming months, leading to: (a) increased recession risks, (b) weakening of inflation, (c) peak aggressiveness of the central bank and (d) lower bond yields.