11 May 2017
Sell in May and go away
Or should we just put some “Vix” in our investment chest?
by Frank O’Nomics
The old stock market saying: “sell in May and go away, come back again on St. Ledger day”, has long been taken as a recommendation to avoid poorly performing markets over the summer. The real idea may well have been to stop worrying about shares and enjoy the summer season (the Lord’s test, Ascot, Wimbledon etc.), but overvalued markets and a background of uncertainty could give some strong business rationale to the adage this year. The danger of an increase in volatility, which as measured by the Vix “fear index” is remarkably low, and a large mystery buyer of derivative contracts linked to this index (dubbed “50 cent” as this is the level he has been paying) has been positioning himself to profit from a financial meltdown. Is he right or just guilty of adopting the rapper 50 cents’ approach of “get rich or die trying”?
Empirical evidence would appear to support the idea of selling in May. Since 1966, the FTSE All-Share index has lost 0.6% on average from May Day to the end of October, and there have been 11 occasions when the fall has been in excess of 10%. For the UK, the Budget is out of the way and investors become wary of the lack of liquidity available in the summer months. This year there is more to worry about. The UK election may be a forgone conclusion, but Brexit negotiations certainly are not, and, from an international point of view, the Trump rally has dangerously inflated the 9-year bull run in US shares. In the UK, the wealth producing effects of a long period of cheap money are showing signs of waning: property prices saw their first quarterly fall since 2012, and consumer spending looks very tired given the extent to which personal borrowing has grown. The simple question is: where is the engine of growth for developed markets?
Perhaps the best question to ask is, “how would a 10% fall in asset prices impact my personal circumstances”? For those close to retirement the justification for becoming more cautious is likely to be somewhat greater. Others will not find an easy answer, particularly when faced with the difficulty of what to do with the cash realised by selling. Holding cash is very expensive when inflation is running at over 2% and bank deposits pay next to nothing. Bonds produce similarly low returns unless you go for riskier corporate bonds, which would effectively negate any bearish view that you were trying to express. The big worry about selling is not finding an opportunity to get back into a UK equity market that, while overvalued, pays you 3.5% in dividend income. While you may miss some dramatic falls, last year’s almost momentary response to the Brexit vote showed just how supportive the huge amounts of cash generated by quantitative easing really is. The bigger danger remains that you could also miss some sharp rises, and to quote John Maynard Keynes; “markets can stay irrational for longer than you can stay solvent” (a phrase seemingly prompted by his needing to be bailed out of some currency positions).
This leaves us with the Vix trade idea. If markets are likely to become more volatile (from a current 10 year low), it may be sensible to buy some “insurance” against a significant sell-off. Unfortunately that is a concept that most investors struggle with. Insuring your house may be an irritating expense given that claims are relatively rare – it is just something that has to be done given that the alternative (being left without a home) is unthinkable. However, insuring your investment portfolio against steep losses is a different prospect and, of the $120m recently spent on buying protection via Vix index options, £88m of the trade has expired worthless. Further, given that this involves trading derivatives, it means trading in a market that few understand.
The least risky approach to taking a cautious view is either to buy some of the more defensive funds that invest in low volatility stocks which tend to underperform a rising market but hold up much better in a market correction, or to consider absolute return funds. This latter group has seen a great deal of demand in recent years, given their approach of wanting to deliver a stable positive return in excess of inflation and interest rates, rather than just to outperform an index (only losing 5% when the market falls 10% is often little comfort). Both of these approaches are different to those of fund managers who are aggressively bearish – a stance which has proved particularly expensive for the likes of Crispin Odey who late last year talked of risks of an 80% fall in UK equities but who has underperformed his peers by around 15% over the last year.
Selling in May would seem to have two things going for it. The first is the opportunity to concentrate on matters other than markets, and the second is to get into a position to exploit a potential buying opportunity. However, the Barclays Equity Gilt study, which looks at data going back to 1899, tells us that equities have outperformed cash in three-quarters of any five-year period (the key being to reinvest any income) and so rather than buying a “fear index” we should probably being mindful of a notional FOMO, or “fear of missing out’” index.
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