Alpha Power Investing NewsletterJune 1, 2020
Four Good Reasons to "Sell in May"
In the long run, no one "predicts" their way to investment success. In the end it is not about "knowing what is coming next" but about "being prepared for whatever comes next." Historically, the end of May marks the end of the typical "favorable" period for stocks which begins on November 1 of each year. Needless to say, due to the coronavirus-induced panic, the "favorable" period was not at all favorable for stock investors this time around. Understandably, different investors have reacted in different ways to recent events. But in the end, investors who have a well thought-out and diversified investment plan - and who stick to their plan - are the ones that will ultimately come out ahead. With the unfavorable "dead zone" months of June through October directly ahead, it may be time for investors to make sure they have some form of "defense" built into their overall investment strategy.
In this month's newsletter we will highlight four reasons why this might be a good year to be prepared to "play defense" during the dead zone.
#1. June through October is Overdue for a Whack
Figure 1 displays the cumulative percent price gain for the Dow Jones Industrial Average during the months of June through October since 1950. Note the vertical red bars that highlight the peaks of previous such periods. Then consider very carefully what happens during the dead zone in subsequent years. Past performance never guarantees future results, but the results displayed in Figure 1 suggest that dead zone performance is due to "revert to the mean", i.e., witness some very bad market performance in the years ahead.
#2. The Current Trend in Price
The hope is that the NASDAQ 100 will lead the other indexes and that they will turn higher as well. And that is absolutely a possibility. But investors should keep a close eye on the trend of these indexes in the days, weeks and even months ahead. As we will see in a moment, when the S&P 500 Index is below its 200-day moving average between June and October the market has lost money overall. Again, this does not mean the market will lose ground in the months ahead, but it does argue that a higher degree of caution is in order.
#3. Combining Seasonality and Price Trend Together
On any given day both, either or none of the indicators can be favorable.
As you can see in Figure 3, the market makes most of its gains when the calendar is between November and May AND the S&P 500 Index is above its 200-day moving average. After May 31 of this year, if the S&P 500 Index is below its 200-day moving average, "Neither" of the factors will be favorable. While this would not preclude the market moving higher it would provide a definite interim warning sign for investors.
#4. Dead Zones after Down Power Zones
The results of this test appear in Figure 4. When the six Favorable Months showed a loss, the Dow during the subsequent six Unfavorable Months lost ground 56% of the time with an average loss of -3%. The cumulative result was a loss of -79.7%.
If a retest of the March 2020 lows is in the cards, the decline could be swift and severe when it comes. On a more positive note, a successful retest of the recent lows could well set the stage for a very strong advance towards the end of the year. In the meantime, given the uncertainty surrounding the U.S. and world economy moving forward - and the factors detailed above - investors may be wise to retain a cautious stance in the months directly ahead.
Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in the charts above do not represent actual trading and are not representative of the returns of any strategy. The illustrations are designed to quantify the effect of certain time periods on the Dow Jones Industrial Average, S&P 500, NASDAQ 100 and Russell 2000 as specified. Indexes are not investment vehicles and persons cannot invest directly in an index. Index funds and ETFs may vary somewhat from index returns due to management fees and portfolio structure. The data used to construct the illustrations were obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.
© 2020 Alpha Investment Management, Inc.