Sell in May and go away?

3 June 2016

The first week of June brought a raft of economic data updates as well as May’s results. A quick look at the table above confirms that the old investor adage of ‘Sell in May and go away’ did not hold true over May 2016, with Global stock markets on average advancing around 0.5% and UK fixed interest bond holdings also generating a positive return for the month.

For the year this puts globally diversified investment portfolios more squarely into positive territory, with only the highest equity content portfolios still struggling around the 0% return line.

The stock market recovery which started in mid-February has consolidated over May and so most analysts have begun to look forward rather than backwards. The recovery had been driven by a major bounce back in commodity prices, especially oil, which calmed fears that energy and commodity related industries would suffer significant corporate failures which may lead to increased stress in capital markets through widespread defaults.

This was almost mirrored in effect for emerging markets by the first meaningful easing of the US$ exchange rate in 3 years and the easing effect this had on capital flows between the developed and the developing world. That is, the outflow and debt servicing pressures from developing/emerging world markets eased and thus fears of financial stress from there subsided as well.

The concerns that economic growth was turning negative because of a further slowing of Chinese growth and a stuttering of the US economy were also proved wrong, as Chinese growth rates stabilised and the US economy experienced positive growth rather than decline.

Level headed actions and communication by central banks further supported the situation and so now the severe stock market correction of January and February which so many read as a harbinger of an imminent global recession seems like a distant memory.

Unfortunately, all this has only taken us slightly beyond where we started the year and now markets are looking for new direction. The economic data releases of the past week (see next article) did not provide strong indications either way, but merely confirmed that the economic bounce back from the winter slowdown has run its course and now economies have returned to their previous slow expansion path.

This growth is precariously close to stagnation or what we call ‘stall-speed’. Such lack of upward momentum makes economic progress more vulnerable to set backs and thus capital markets more inclined to overreact to any resurfacing of previous concerns.

One of these concerns was untimely interest rate rises by the US central bank the Fed. There had been suggestions from US central bankers over recent weeks that they may raise rates as soon as June driven by strong US employment – even before there would be certainty about the future path of the UK’s EU membership.

The mixed data of the week has now made this far less likely, although US new jobs data was so much below expectations that markets were suddenly focused more on the surprise slowing of the employment market, than showing relief that the rate rise had most likely been put off for another month – to July.

The combination of lacklustre economic progress and the political risks of the UK’s EU referendum and D Trump as the presidential candidate for the US Republican party, has generated a murky short term investment outlook. Three scenarios are possible in my view:

  1. Markets look beyond the short term political risks and break out of their sideways trading range of the past 12 months on the view that the economy is more resilient than anticipated
  2. Politics drive markets and uncertainty holds them back and unexpected results (Brexit, Trump) derail them
  3. Once political uncertainty subsides markets still refuse to progress upwards as the negative impacts of a rising US$ and weak oil and commodity prices return as obstacles to sustained global growth

In such an environment it feels not a good choice to take strong positions in favour of one of the other scenario. We have therefore decided to keep the Tatton portfolio invested in line with their risk profile allocations as they are, but adjust some of our underlying fund choices to reflect that the overall economic outlook is gradually improving. This should give advantage to those fund managers whose style is focused on value stocks without income focus.

On the other hand, we are reducing investment to some of our strongest performers of recent years, whose dividend yield or growth focused stock picking strategies have led to elevated valuation levels of their underlying holdings which we no longer regard as sustainable.

We will, however, not follow the suggested 0-2% reduction in equity investment in the strategic asset allocations by risk profile providers Morningstar, nor their broad divestment from UK commercial property. We regard those moves as ill-timed and therefore potentially damaging to the 2016 return potential of the affected risk profiled portfolio strategies.

Indeed, should stock markets suffer another sell-off in the run up to the EU referendum, then we will seriously consider to increase our equity allocations beyond their risk profile target weights to take advantage of lower entry prices.