The adage “Sell in May and go away” is being widely discussed. It is a common agenda followed by stock traders as the equity market generally advances during the October to April period, and then starts to retrace in May. But, this time around, May won’t be a particularly bad month for the stock market.
Among the two pillars of the U.S. economy, consumer confidence remains at strong levels and corporate earnings growth continues to pick up momentum. While the technology revolution is expected to drive most of the sectors, an uptick in interest rates reflects an improving economy. Thanks to the slew of positive developments, investors should focus on fundamentally sound companies that can make the most of the current scenario.
Banking on the Adage
Sell in May and go away encourages investors to sell stock holdings in May to avoid getting affected by the seasonal decline in equity markets. The strategy also involves getting back into the equity markets in November, thereby evading the typical volatile May-October period. Historically, stocks have underperformed in the six-month period commencing May and ending in October, compared to the six-month period from November to April.
Since 1950, Dow Jones posted a meager return of 0.3% in the May-October period, while during the November-April period the blue chip index registered an average gain of 7.5%. Mostly lower trading volumes in the summer season and substantial increase in investment during the winter months are cited to be the main reasons behind this discrepancy in returns.
Here is Why You Shouldn’t Sell in May
May is upon us, and even though the popular adage advices us to stay away from stocks, we shouldn’t be doing so from an investment standpoint. This is because the two pillars of the U.S. economy – consumers and corporates – still look solid.
Consumer Confidence Dips in April But Remains Strong
On the consumer side, we have seen few signs of soft data in recent weeks, mostly in areas of retail sales. In fact, the U.S. economy fell in the first three months of the year on tepid consumer spending levels. Americans cut back outlays on big-ticket items like cars, but, let us not forget that the economy has a habit of starting the calendar year slowly and then picking up momentum in spring and summer. Moreover, the slowdown appeared tied to temporary effects that are likely to give way to a rebound in the coming months.
Leading indicators of consumer health, in the meanwhile, remain strong. In March, Consumer Confidence Index touched 125.6, its highest since Dec 2000. Understandably, the index dropped to 120.3 in April but still remained strong, according to Lynn Franco, director of economic indicators at the Conference Board.
The housing market has picked up steam, jobs growth remains strong, unemployment rates continue to be at very low levels and wage growth is showing considerable improvement in many areas. Two of the biggest areas, manufacturing and construction, are seeing increased job additions, which has been lagging since the 2007-2009 financial crisis.
Q1 Earnings Gain Traction
Turning to corporate America, we have entered the first-quarter earnings season. In the first quarter, total earnings are likely to increase 9.7% from the same period last year on 5.9% higher revenues, with Technology, Finance, Industrial Products, and Basic Materials expected to post double-digit growth in earnings. This will follow 7.4% earnings growth recorded in the fourth quarter of 2016 on 4.8% higher revenues, the best performance in nearly two years (read more: Q1 Earnings Season Shows Broad-based Momentum).
Notably, Q1 results are likely to see expedited earnings growth, as it is expected to gain momentum from the preceding quarter, showing significant improvement over the third quarter of 2016. This level of growth should support the corporate side of the economy and provide a tailwind to the market.
We, in the meantime, continue to see abundant opportunities in many sectors of the market, particularly technology. Companies have realized that investment in technology is the need of the hour to improve productivity and lower production cost. As a matter of fact, technology driven transformations are also taking place outside the tech sector. In order to transform traditional non-tech industries into efficient global enterprises, data collected is combined with the cloud computing and artificial intelligence applications. Many experts believe that the stage is set for ‘smart’ factory, the next step toward the fourth industrial revolution.
Investments in new software and data analytics bode well for the technology sector. For the said sector, we already have Q1 results for 30 companies in the S&P 500 index, whose earnings are up 17.7% from the same period last year on 6.2% higher revenues, with 80% beating EPS estimates and 73.3% surpassing the revenue mark. These companies account for 57.4% of the sector’s total market cap in the index. Tech heavyweights including Amazon.com Inc AMZN and Alphabet Inc GOOGL had already posted big gains following upbeat earnings. Both these companies are now neck-and-neck in the race to the $1000-per share mark (read more: The Tech Sector's Strong Earnings Power).
Rising Interest Rates Indicate a Strong Market
Prospects of higher U.S. interest rates and valuations in a broader context hint at a healthy economy. The Federal Reserve is projecting two more rate hikes this year, and barring some major changes in the economic scenario, the markets seems to be comfortable with this pace.
The Fed hiked rates for the third time since the global financial crisis in March, in a widely expected move that reflects confidence in the strength of the economy. The Fed raised its federal funds rate to a range of 0.75% to 1%. The policy rate rose by 25 basis points to 1% for the first time in a decade (read more: 5 Biggest Winners from the Fed Rate Hike).
5 Best Stocks to Buy in May
Since a ‘buy-in-May’ opportunity maybe playing out in the equity market, investing in solid stocks will be prudent. These stocks not only possess a Zacks Rank #1 (Strong Buy) but also are poised to gain significantly in the near term. You can see the complete list of today’s Zacks #1 Rank stocks here.
Such stocks also flaunt a VGM score of ‘A’ or ‘B’. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three metrics. Such a score allows you to eliminate the negative aspects of stocks and select winners.
Tech Data Corp TECD is a wholesale distributor of technology products. The company has a VGM score of ‘A’. The Zacks Consensus Estimate for its current year earnings soared 47.4% over the last 60 days.
The company is likely to yield a return of 45.8% this year, higher than the Retail - Computer Hardware industry’s gain of 23%. The company outperformed the broader industry on a year-to-date basis (13% vs 10.6%).
Best Buy Co Inc BBY is a provider of technology products, services and solutions. The company has a VGM score of ‘A’. The Zacks Consensus Estimate for its current year earnings increased 5.4% over the last 60 days.
The company is likely to yield a return of 3.8% this year, in contrast, the Retail - Consumer Electronics industry is projected to give a negative return of 3.5%. The company outperformed the broader industry on a year-to-date basis (21.4% vs 16.8%).
Papa Murphy's Holdings Inc FRSH is a franchisor and operator of the Take 'N' Bake pizza chain in the U.S. The company franchises the right to operate Take 'N' Bake pizza franchises and operates Take 'N' Bake pizza stores owned by the company. Papa Murphy's Holdings has a VGM score of ‘B’. The Zacks Consensus Estimate for its current year earnings surged 50% over the last 60 days.
The company is likely to yield a return of 31.3% this year, more than the Retail - Restaurants industry’s gain of 6.3%. The company outperformed the broader industry on a year-to-date basis (15.8% vs 6.7%).
Caterpillar Inc. CAT is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company has a VGM score of ‘B’. The Zacks Consensus Estimate for its current year earnings jumped 32.4% over the last 60 days (read more: Caterpillar Tops Q1 Earnings & Revenues, Raises View).
The company is likely to yield a return of 18.4% this year, higher than the Manufacturing - Construction and Mining industry’s gain of 13.8%. The company outperformed the broader industry on a year-to-date basis (10.3% vs 9.6%).
Casella Waste Systems Inc. CWST is a solid waste services company. The company has a VGM score of ‘B’. The Zacks Consensus Estimate for its current year earnings climbed 23.7% over the last 60 days.
The company is likely to yield a whopping return of 147.4% this year, more than the Pollution Control industry’s gain of 24.8%. The company outperformed the broader industry on a year-to-date basis (21.2% vs 0.9%).
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