By Terry Connelly
It’s baseball season, so superstition is back in fashion in the stock market – not least, the old chestnut, “sell in May and go away!” And this little rhyme is not really like wearing the same socks to keep a win streak going; indeed, it’s all about knowing when to “fold” on the 2013 equity winning streak, take your cash and head to the beach. And there are even some statistics that bear out the claim that stock market returns in the May-September period do tend to run lower than over the remainder of the 12-month cycle commencing on May Day.But as Rex Kramer (Robert Stack) warned us so memorably in the immortal movie, “Airplane,” when the hero pilot suggested an apparently obvious life-saving maneuver: “No, that’s just what they’ll be expecting us to do!”
Trusting the conventional wisdom
In this case, as in the past three years when “sell in May” seemed to work right (at least until about July), “they” are the hedge funds and other money managers who missed the Q1 rally in stocks and want to get back in on the cheap to bring their performance at least in line with market indexes – which don’t charge for their services. These folks have been praying (loudly and with many acolytes among market commentators) for a “correction” in the market of five to ten percent to give them a chance to buy low and sell high after the next rally, which happened to come along in late summer each of the past three years! Fool us once, its your fault; fool us four times in a row – maybe we should listen to Rex!
Why should those who actually got the market right in Q1 cash in their hard-earned profits just to give hedge funds a leg-up to correcting their relatively poor performance in the same period? Why give them the profits that will accrue after the market sells down ten percent or so as it did the past three years in Spring just to come bouncing back when the various Armageddon scenarios conjured up in May didn’t quite materialize. Greece didn’t implode (neither will Cyprus); Germany didn’t abandon the euro (it won’t this year either); Italy and Spain didn’t sink under the weight of their borrowing costs (they won’t in 2013); the euro didn’t go to parity with the U.S. dollar or collapse altogether (it’s still around at nearly the same relative value as it has held for three years).
And why is it that only declines in the stock market are termed “corrections” – as if only downside moves are “correct” while upward moves are by nature “incorrect?” The short sellers tend to dominate market terminology in ways that tilt to their objectives, largely because ordinary investors don’t short stocks and don’t realize that market pessimists are no more inherently credible than incorrigible stock promoters. A more judgmentally useful vocabulary would focus on more neutral terminology like market “consolidations” or “retracements” that don’t imply that sell-offs are inherently “correct” reflections of economic reality.
This is especially true when the market hits a new five-year high. The proposition that this event calls for a “correction” presupposes that something is amiss when the aggregate value of the market finally climbs back to where it stood just before the financial house of cards we were living on collapsed. Is the aggregate value of public corporate America seriously not worth a dime more than in 2008? Corporate balance sheets are in much better shape, they’re flush with cash, earnings have set records daily, and phony leverage has been largely washed out – why wouldn’t all those adjustments justify a higher market multiple?
Still, a fall is possible
And yet ... there are potential circumstances that could trigger truly significant falls in the market averages. Let’s look at some of them and rate the chances that such a “sell in May” event might really occur this time instead of the phony “sky is falling” tales we were told in 2010, 2011 and 2012.
1) The Federal Reserve begins to dial back its bond-buying program “early.” The chances of this occurring have been reduced from a month ago by tame inflation plus the lackluster jobs, manufacturing, durable good and GDP reports over the past couple of weeks. The Fed “hawks” can make that the overall economy is approaching “escape velocity,” and the half-percent cut in GDP attributable to “Sequester Anxiety” alone (even before the actual cuts hit) makes the case just the opposite.
2) Another “flash crash” hits stock exchanges, not just an individual stock as has just happened with big public tech companies like Google (GOOG) and Symantec (SYMC). This would be an especially troubling May-time anniversary, especially if it seemed the result of a cyber attack designed to disrupt markets. It probably has only a little more likelihood than the Fed-changing course – but certainly can’t be ruled out. And it would take a longer time for recovery – not a “flash in the pan.”
3) Another terror attack on a public event: the Kentucky Derby, the Indy 500, the NBA playoffs – one of these the markets can absorb, but another in short order could unleash a much broader “risk-off” mentality far beyond the stock markets.
4) Another, deeper banking sector crisis born of unanticipated trading losses. Last time around only Jamie Dimon paid a public relations (and compensation) price, and even the large sums lost were within JP Morgan’s (JPM) earning power. If a major European bank were to suffer severe distress, however, the euro authorities have not yet cooked through the mechanisms needed to keep contagion from spreading. Then we really would face a euro currency at serious risk of collapsing, with adverse and immediate consequences for all the worlds’ economies.
5) Finally, the biggest risk of all: Syria spinning out of control beyond its borders and triggering responses ranging from Tehran to Tel Aviv to Washington and Moscow. Markets need beware of red lines as much as red ink. This is the space that bears most watching as we enter May.
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.
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