Selling in May?

Revisiting the old adage

Seasoned investors know that financial markets have a habit of doing what will make the most people wrong. Heading into this year, after an awful 2022, most were bearish as a recession was on the horizon, and risk assets were battered and beaten up.

However, entering May, it seems as if everything went in the opposite direction from consensus predictions. One of the most popular predictions was the collapse of Europe: the result of an energy crisis and ground war in the East. Don’t look now, but after a warmer winter, the French and German stock markets are at all-time highs.

What of those beaten-up technology stocks? They are leading the charge higher. Fueled by visions of AI growth and opportunity, giants such as Microsoft and Nvidia are higher by 30% and 80%, respectively, on the year. The strength in the crypto market is also notable as Bitcoin has recovered to $30,000 and is beginning to offer some hints that it may yet become a credible alternative financial asset in times of stress.

One of the major fears heading into the year was centred around earnings. The bulk of the market selloff in the past year was due to multiple contractions. For this year to be positive, we would need to rely on earnings growth to kick in. Heading into a recession, with margins under pressure due to cost inflation, it seemed like a tough ask. Yet once again, overall earnings season is coming in ahead of fears as the consumer remains resilient.

One area that saw some earnings contraction is the commodities, as growth slowdown concerns have impacted commodity prices. Yet many of these stocks have held in well as M&A has picked up in this group, with larger companies looking to add growth projects after years of a lack of exploration and development.

Markets have also been able to isolate and look over the valley of a U.S. banking crisis. The rapid collapse of several U.S. regional banks, in hindsight, seemed obvious as they had been aggressively lending out at low rates while holding long-duration assets that were declining in value with rate hikes. We still don’t know the full impact of this crisis on the economy, but it will have the effect of tightening financial conditions.

With slowing growth in the economy and inflation readings beginning to revert towards target levels, central banks are now looking to pause their rate-hiking programs. Some of the recent market gains have been built on optimism of this pause, as investors have been trained to buy on any dovish comments. Yet this is more likely to be looked at as a hawkish pause. CPI readings remain too high, but with stress beginning to appear in the banking system, the pause may be more out of caution of breaking something vs in celebration of a victory over inflation.

Another stress on the horizon is appearing from Washington with an impending debt ceiling issue. Many traders remember these debates from the past decade as non-events, but it can be dangerous to just assume rational thought will overcome in present-day politics. Politicians tend to need a push to reach the correct result; as a reminder, in 2011, nothing happened until the market dropped 20% and caught their attention.

After a strong start to the year and many unknowns ahead of us, one of the biggest curiosities in the market is how low the fear gauge (VIX index) is. With the cost of insurance at multi-year lows, adding protection to portfolios at these levels may not be the worst idea. All it takes is one of these risks to shock compliant investors, and you will be thankful for having it.

“Sell in May and go away” is a nice little rhyme, but it hasn’t worked very well of late. Given that not many other predictions have come to pass this year, will this be the year the saying works as good advice?

Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.

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