There’s Truth in This Market Maxim
Investors love to parrot adages and strategies.
At a party last weekend, the conversation turned to the markets and investing. And at one point, I simply sat back and chuckled as I listened to a barrage of sound bites...
"You know when the best time to plant a tree is? Yesterday. You want to know the second best? Today."
"Think risk first, then reward."
"Buy companies, not stocks!"
"Don't fight the tape."
On and on it went.
Being that it was Greek Easter, I blame the fortune cookie conversation on too much roasted lamb and Metaxa, a blend of brandy and wine.
Now, many Wall Street sayings remain relevant after decades and even centuries because there are kernels of truth in them.
To support my argument, I'll borrow a maxim from financial media pioneer Dick Davis: "We should treat market truisms with respect, but not as gospel."
Because understanding a Wall Street truism can make us better - more profitable - investors.
Sell in May? Kind of...
As a trend trader, I'm well-versed in market timing axioms.
For instance, there are few market sayings that irk me more than "Sell in May and go away. Don't come back until St. Leger's Day." (Or for Americans, "Don't come back until Labor Day.")
I'm not irked by the saying because it's necessarily wrong...
On Monday, I showed that April is one of the best months for stocks before we skid into the "summer lull." (Though by no means do I think investors should sit on the sidelines because of that.)
I'm irked because hailing "Sell in May" as gospel is dangerous. And you're probably going to do more harm than good to your portfolio by following it.
The reality is that this saying applies to a specific sector: retail.
Retailers rake in most of their money during back-to-school season and the holiday crush.
Those events are in the back half of the year.
And we see this consumer spending trend play out in share prices.
Retail stocks typically start gaining momentum in October - they drive higher on third quarter earnings announcements. That optimism continues through fourth quarter reporting in February.
But it all starts crumbling when first quarter earnings are publicized in April and May.
I'll use a revenue chart from Macy's (NYSE: M) so you can clearly see why...
The big spike each year represents fourth quarter revenue. After all, there are plenty of reasons for consumers to shop during the winter months.
Investors get excited as revenue surges from $5 billion to around $9 billion...
But they're equally deflated to see it crash back down again, even though it happens every year.
Since October, shares of Macy's are up more than 34%.
They soared on third quarter earnings... just as they've done in four of the past five years. And they spiked higher on fourth quarter earnings, as Macy's shares have consistently done for a decade.
But that's likely it for now.
This is where "Sell in May" comes into play.
According to my own Prime System research, Macy's shares have fallen on first quarter earnings six times since 2010. And the average one-day drop on the report is more than 4%.
With no big spending events between Easter and back-to-school season, May is the start of a sluggish period for a wide range of retailer shares, not just Macy's.
Sell Most Retailers Now
My proprietary Prime System Retail (PSR) Index performance from May to October is a good illustration of this "blah" period for retail...
The PSR Index is made up of more than two dozen retail companies, including Macy's. And this trend shows why we don't buy a lot of retail shares between now and October.
It's because they tend to fall. So we're just throwing our hard-earned money down the drain.
Since 2000, the PSR Index has gained just five times during the May to October period. And as you can see, the biggest gains followed broad market collapses - they were rebound periods.
Does all this mean there are no retail companies for the summer months? No.
We're just more selective about what type of retail we buy.
And this illustrates the core of my investing philosophy: playing the strength of a rotating sector strategy.
This is where investors target specific companies during their best months of the year, exit at the peak and roll everything over to the industries that are about to hit their most bullish months of the year.
If you're an investor buying retailers now because they've been on a great run the past six months, you may be in store for disappointment.
The trend is against you.
As I often say, there's always a bull market somewhere. You merely have to know where to look. And you have to know what market maxims to treat as gospel.
Thoughts on this article? Leave a comment below.