Sell in May and stay away?
One of the oldest aphorisms on Wall Street - "Sell in May and go away" - is that it is in investors' best interests to sell their stocks at the beginning of May and return to the market at the beginning of November.
As you can see from the chart above, May to October (with the exception of July) are all historically weak months. Playing the stock market is essentially a winter sport.
But not all assets behave in the same way. The commodity copper has a different seasonality, as seen above, with strong months in July, November and December.
Asset management is about reducing risk in a well-diversified portfolio. The main asset classes are equities, bonds, property, commodities, currencies, alternative investments and hedging. A typical portfolio is often a mix of 60-75% equities, 20%-35% bonds and 10% alternatives (including commodities and property).Insurance companies are obliged to pay out a certain amount to pensioners in a few years' time. This means that they have historically held a large proportion of bonds in their portfolios.
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EXAMPLE OF PORTFOLIO ASSET ALLOCATION
Source: Carlsquare.
Larger investors tend to rebalance their portfolios at different stages of the economic cycle and in times of global unrest. In recent years, the correlation between the price movements of different stocks has increased. This makes it important for portfolio managers to find assets that have a low correlation with equity markets.
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Finding uncorrelated assets is becoming increasingly difficult as asset managers tend to use more of the same strategies and computer trading (algo trading) becomes more dominant.
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PORTFOLIO WEIGHTING EXAMPLE
Source: Carlsquare, inspired by S?derberg & Partners.
Equities are broken down by geographical region such as Europe, North America, Asia and other emerging markets. US equity markets account for around 50% of the weight in global equity indices. Other countries' stock markets are much smaller, with Japan accounting for 7% of global equity market capitalisation, the UK 6%, France, Switzerland and Germany 4% and China just 3%. In the case of the US and China, these figures can be compared with 26% and 17% of world GDP respectively. The regional weighting also gives a currency exposure. From a Swedish perspective, a global equity portfolio is a hedge against a weak SEK.
The Magnificent seven stocks (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta Platforms and Tesla) represent 29% of the S&P500 index. An asset manager could allocate a proportion of equities to sectors with expected growth return above average, such as Information Technology and Health Care. A portfolio manager should have about 15% of a global equity portfolio in the US Magnificent Seven just to be index neutral. Another (more common) strategy is to have a portfolio that closely tracks a local equity index. The above makes a distinction between the performance of value and growth stocks.
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PERFORMANCE (3-YEAR CHART) OF GROWTH (RED) VS. VALUE STOCKS (BLUE)
Source: Carlsquare/Stockcharts.
Bond loans are usually low-risk investments that pay interest on a quarterly or annual basis. When the bond matures, the issuer repays the bondholders the full amount of the loan.
As can be seen from the chart above, bonds have been bad investments for the last three years as inflations has ticked upwards.
Source: Carlsquare/Stockcharts.
The HYG ETF above tracks the performance of high yield bonds in North America. HYG behaves more like the stock market.
One of our main findings when looking at the performance of equities, equity indices, bonds, real estate and commodities is that the latter, especially gold and soft commodities, have acted as the best hedge against inflation. After all, energy, food and materials are often the main drivers of inflation. In the 1970s, the last time we had a significant rate of inflation, the main trigger was the oil price, which is controlled by the Opec countries.
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Commodities can be divided into metals and soft commodities (food and food ingredients)
Gold has a special status as a precious metal. It is seen as a good hedge against rising inflation and recently gained a lot of ground.
The copper price has historically been linked to global industrial production, where China has been the largest buyer of industrial metals since around 2000. Silver is another example of a metal linked to industrial demand, but also to computer performance for AI applications due to its excellent conductivity.
DBA AGRICULTURE (RED) VS. WTI OIL (GREEN), ONE AND A HALF YEAR- WEEKLY CHART
Source: Carlsquare/Stockcharts.
The crude oil market is an oligopolistic and highly politicised market, with the US, Russia and Opec as the dominant players.
Soft commodities (mainly food and food ingredients) are mostly affected by weather conditions and crop diseases in the larger producing countries (often in the global south).
Any disruption to these conditions tends to lead to shortages and price increases in the soft commodity in question.
Among the commodities included in the DBA - Invesco DB Agriculture Fund, cocoa and coffee futures have been the biggest contributors to the YTD rally. These account for just under 40% of the fund's total value at the time of writing, with live cattle in third place at ~10.4% of the fund's total value.
Cocoa has been on a parabolic rise that has been covered extensively, including by major news outlets. With almost 60% of cocoa grown in C?te d'Ivoire and neighbouring Ghana, supply is more vulnerable to shocks than other commodities. With heavy rains in normally dry periods, diseases such as black pod and swollen shoot virus have devastated crops and sent futures prices soaring.
The FTSE index (London Stock Exchange) acts as a defensive investment with a high proportion of materials, food, and pharmaceutical companies.
?Gold is traditionally seen as a inflation hedge, and is also breaking up.
Property is primarily used by insurance companies and other institutions to gain exposure to an asset class that has historically yielded higher returns than bonds. A fully let property provides a predictable cash flow, with rental income tending to rise in line with inflation. The change in the market value of a property is primarily influenced by the growth in rental income, combined with changes in the yield required by investors.
Years of low interest rates have left the property sector over-leveraged, especially in Europe. Therefore, the real estate sector needs capital injections, including transactions in which properties are sold by companies with higher debt to owners with more equity.
Equities are more liquid and therefore rise and fall in price more quickly than property. This leads institutions to buy property late in the cycle when prices are already high.
Back to the question of seasonality. Is it time to get back in or sell more?
Oil has started to trade lower again as demand is a little weaker and US inventories are building up again.
But looking at the daily chart, we can also notice that oil is now testing MA100, which can be a support.
Interest rates fall when inflation expectations fall. Note that the 10 year yield is now trading at the support line of a rising wedge. If rates rise from here, this could be the catalyst for the equity market to turn lower again as equities are very interest rate sensitive at the moment. In the coming days there will be several bond auctions in the US and the demand for them will determine the outcome for rates and equities.
With lower interest rates, we see a new leg higher for the equity market, with technology leading the way.
From a technical point of view, there are two developments to consider. The recapture of the MA50 is positive for the equity market. If oil prices continue to trade lower (or at the same level), the turnaround for a new high in the stock market may be in place. Note that the MACD on the bottom of the chart is giving a buy signal.
However, we are more inclined to see the S&P 500 making a new lower high with another leg higher in interest rates as a catalyst. This would mean a continuation of the downtrend for the stock market.
Unfortunately, it is too early to tell which scenario will play out. We have to take it one day at a time.
Happy trading!