U.S. stocks this month are defying the historic call to 'sell in May and go away' with the Dow posting its longest win streak since December and the S&P 500 reversing nearly all the declines it recorded over April.
"Sell in May" has been a shorthand Wall Street strategy that encourages investors to dump stocks at the end of April, retreat into cash or fixed-income assets, and return to equity markets later in the summer.
While easy to remember for its rhyming tag line, the phrase really hasn't been a terribly successful tactic.
Deutsche Bank data note that holding the S&P 500 benchmark from the end of April to the beginning of September has generated returns very similar to those of a "sell in May" strategy that parks cash in the bond market.
Selling stocks and placing the proceeds in cash over the same period, the data indicated, has generated notably inferior returns.
The stock mantra, "sell in May and go away," is catchy, but has a mixed record of success.
This month, at least so far, looks set to provide a significant test to the "sell in May" thesis, with the S&P 500 now up 3.7% and within touching distance of its mid-March record, and the Nasdaq powering 4.87% into the green.
The Dow, of course, is riding an eight-session win streak and has gained about 4.5%, with the 30-stock average now setting its sights firmly on the 40,000 point mark.
Bank of America's regular Flow Show report, meanwhile, notes that $14.8 billion in investor funds found their way into equity portfolios last week, the most since mid-March.
A big move into stocks — and bonds as well
Curiously, the report also notes that bond funds gathered their largest weekly inflow, $17.8 billion, in nearly three years, suggesting investors' bets that fading inflation prospects and slowing growth will snuff out the idea of a "no landing" for the U.S. economy and trigger a broader rally fixed income markets.
The Commerce Department's April inflation reading will provide the first data point on that trade idea next week. Economists are looking for a moderate decline in the monthly CPI report, slated for May 15, as well as a slowing in overall retail sales.
That said, the University of Michigan's benchmark consumer sentiment survey for May showed an uptick in year-ahead inflation prospects, which rose to 3.5% from 3.2% in April. And the Atlanta Fed's GDPNow forecasting tool suggests a current-quarter growth rate of 4.2%
Neither of those readings, of course, suggest the kind of "no landing peak" that would trigger a big fixed-income rally.
"If spending slows down and inflation increases, we’ll get the opposite of the Goldilocks scenario that many were hoping for," said Chris Zaccarelli, chief investment officer for the Independent Advisor Alliance in Charlotte. "And the Fed will be in an especially difficult position of choosing between accommodating a slowing economy and fighting increasing inflation expectations."
Fed Chairman Jerome Powell and his colleagues will publish fresh growth and inflation forecasts next month.
Chip Somodevilla/Getty Images
A risk worth taking?
And elevated Treasury yields pose a key challenge to stock market returns, according to Comerica's chief investment officer, John Lynch, in the form of a lower equity risk premium.
That's effectively a measure that calculates the potential gains of holding riskier stocks compared with safe-haven Treasuries.
Taking the current forward price-to-earnings multiple for the S&P 500, which is around 21 times, and adjusting for the current 10-year Treasury yield of around 4.5%, generates an equity risk premium of 0.26 percentage point, the lowest in nearly two decades.
"History shows that as the [equity risk premium] narrows, the forward return potential for the S&P 500 declines to approximately one-half its average gain when the relative advantage of owning equities is above ERP trend," Lynch said.
"Fortunately, corporate profits have been coming in above expectations, and to the degree future guidance continues to surpass forecasts, the 'E' should substantiate the 'P' in the S&P 500’s valuation metric," he added.
Earnings, as always, are in focus
That does put a lot of weight on both the tail end of the first-quarter earnings season, which has about two weeks of blue-chip reports to digest, and the start of the June-quarter updates later this summer.
LSEG data suggest collective first-quarter profits for the S&P 500 will have risen 7.4% from a year earlier to $467.9 billion, a $5 billion improvement since the start of the reporting season.
Looking into the three months ending in June, LSEG sees that year-on-year growth rate improving to 10.6%, with profits rising to a share-weighted $495 billion.
In between, of course, comes the Fed's June policy meeting, which will include fresh growth and inflation projections — and a new set of dot plots, the Fed officials' rate projections — for the back half of the year.
"The Fed is walking a tightrope as they balance both mandates of price stability and growth," said LPL Financial's chief economist, Jeffrey Roach. "Although it’s not our base case, we do see rising risks of stagflation, a concern the markets will have to deal with, in addition to the impacts from the presidential election."
At present, markets are forecasting little chance of that the Fed will cut rates before its September meeting, and any upward bias in the new dot plots will likely keep Treasury yields elevated and the ERP at its current two-decade lows.
And while that might not be enough to justify the "sell in May" thesis, it does leave stocks positioned to see only modest gains over the summer months.
