Two more reasons we might not need to “Sell in May” are that the business cycle and earnings are both healthy and expanding. We believe the current economic expansion has the potential to continue for at least the next 12 to 18 months based on our analysis of the leading indicators. Most bear markets occur near recessions, and the U.S. economy is simply not showing signs of excesses that historically have built up and led to the end of prior business cycles. In the absence of recession, any stock market declines tend to be more modest. We expect more volatility in the second half of the year, but the generally favorable economic backdrop should encourage the dips to be bought.
Earnings have been perhaps the biggest driver of this year's stock market gains, with the possible exception of policy optimism (the two are related, so perhaps both can stake claim). Although hard to estimate, policy could add several percentage points to 2018 earnings after what we anticipate will be mid-to-high single digit earnings gains for S&P 500 companies in 2017. We expect earnings to be supported by a slight pickup in economic growth, a stable U.S. dollar, and rebounding energy sector profits.
Corporate America is doing even better than that pace in the first quarter. A very strong 75% of companies have beaten consensus estimates, producing a growth rate of near 15% with more than 400 S&P 500 companies having reported. Most companies have offered upbeat outlooks, reiterating or increasing guidance, which has led estimates to be resilient. We expect the strong near-term earnings outlook to help support stocks over the next three to six months as it has in recent weeks.
Buying At All Times Can Be A Good Thing
The S&P 500 closed at a new all-time high on Friday. This could, perhaps counter-intuitively, be another reason not to “Sell in May.” Analysis of the S&P 500 Index indicates that from the date of any given all-time high, the index has historically hit another all-time high within one month 92% of the time. Extending this time frame to three months increases those odds to over 97%, and extending to one year the odds approach 99%. Based on those odds, you have a very good chance of seeing another all-time high pretty soon after hitting one.
Although these numbers are reassuring, they only tell a small part of the story. Hitting another all-time high after a short period of time is great, but if those gains evaporate before a sale occurs, they really don’t matter. Are those gains sustained so they can be captured by investors over a longer-term investment horizon? The answer, historically, has been yes.
If you bought at an all-time high, the S&P 500 was on average 0.5% higher after one month. After three months the average gain was 1.8%, and after one year, the average gain was 7.9%. Six-month and one-year performance has been slightly better than the average over the entire time horizon we studied, back to 1928. Longer time horizons tend to favor investing when markets have not been at all-time highs, though the numbers still show strong performance is possible even when investing at all-time highs. It is human nature to be nervous at such times, but the numbers support investment consideration.
Conclusion
“Sell in May” is one of the most popular investment clichés, but it also has a good deal of historical data to back it up. But remember, no investment rule of thumb works all the time. With global equity strength heading into this weak seasonal period, improving earnings, a business cycle showing little sign of recession, and history saying new highs have usually been followed by more new highs—the odds that we see a major “Sell in May” event this year is minimized in our view. This isn’t to say volatility won’t pick up later this year, we think it will; but we would consider using any weakness as an opportunity to increase equity exposure.
Thanks to Jeffrey Buchbinder and David Tonaszuck for their contributions this week.
Burt White is chief investment officer for LPL Financial.