The title phrase has been the mantra for many stock traders for years and seems appropriate to look at now since we are almost at that traditional selling time and stock traders do tend to be creatures of habit and very focused on patterns that have worked in the past.  Like the “Santa Claus Rally”, the “September Swoon” and the “January Effect”, the trading patterns are usually traced back to the impact of human emotions on stock market investing.  Investors have traditionally been optimistic in their outlook for growth and therefore would normally look positively on the potential for the year ahead in late fall and early in the year and would therefore tend to be buyers.  As the reality settles in throughout the year that results may not be as good as expected (or promised), then investors turn into sellers.  By late fall there is the added impetus of ‘tax loss selling’ which then gives way to buying in the December period.   The whole process is simple and logical in many ways.

In terms of the history of the “Sell in May” theory, the chart below was provided by RBC Securities, using S&P500 data back to 1956.  The simple trading rule has been to own stocks in the November through April period and switch into bonds in the remaining months, which has yielded an annual return of 13.5%.  This has been far superior to return of 9.2% for a buy-and-hold stock strategy or 7.7% for bonds alone.  Within the stock market, at the sector level, cyclical stock groups (i.e. resources) tend to outperform in the November to April period and underperform in the summer months.  This was clearly the case in both 2010 and 2011, where resource stocks peaked in April and then went into sharp correction modes until rallying later in the year (starting in August of 2010 and then again in October of 2011).

Sell in May usually Works

But stock markets are never that easy and anytime patterns take place that everyone becomes aware of then the impact of the pattern diminishes.  The weakness in March and April this year for stocks in general and cyclical stocks in particular may have already accounted for a good deal of the weakness expected over the May-October period.  While we don’t want to ‘fight a tradition of over 50 years’, stock market investing remains to us a science in many ways, driven by the fundamental backdrop of global economic growth, corporate earnings, monetary conditions (i.e. interest rates) as well as existing stock and sector valuations.  Throw in some recognition of the overall sentiment of investors and you have all the ingredients for making the judgement as to which direction stocks should be headed, irrespective of what month of the year we are in!

On that basis we find the Canadian stock market particularly attractive right now.  Worries about global economic growth and a potential financial crisis in Europe have lead to a wholesale liquidation of resource stocks by foreign investors foreign investors, who sold $2.6 billion of Canadian stocks in January and February alone. This represents the worst ever January-February outflow.  Despite exhibiting both oversold and undervalued conditions, Canadian resource stocks just cannot seem to get a bid.  One of the biggest worries for investors has been the outlook for the Chinese economy, since China is the world’s largest consumer of raw materials and the marginal buyer for most commodites since the mid-1990s.  It is well understood that the Chinese economy is decelerating, but the magnitude of the slowdown is unknown, so investors have just been selling.  Our view is that these fears are completely unjustified.  While Chinese authorities have projected a reduction to an annual growth rate of 7.5% in their new Five-Year Plan, this is only 0.5% below the prior plan, which was easily surpassed with actual results in the prior plan period.  Moreover, China is now the 2nd largest economy in the world.  Even 7.5% growth on that larger base is going to lead to substantial global demand for most basic raw materials, even as China’s own production of many of these products increases.  China’s GDP was over $7 trillion in 2011 and will be over $8 trillion at the end of this year if it manages to achieve only 7-8% real growth.  That means close to a trillion dollars in new demand every year, much more than during the boom years of 2003-07.

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