This month, U.S. stocks are defying the historic call to “sell in May and walk away,” with the Dow posting its longest winning streak since December and the S&P 500 reversing nearly all of the declines it recorded during April.
“Selling in May” has been a shorthand Wall Street strategy that encourages investors to dump stocks in late April, retreat into cash or fixed-income assets and return to the stock markets later in the summer.
Related: Best Single Trade: Wall Street Veteran Picks Palantir Stock
While easy to remember for its rhyming catchphrase, the phrase hasn't really been a very successful tactic.
Data from Deutsche Bank shows that holding the S&P 500 benchmark from late April to early September has generated very similar returns to a “sell in May” strategy that puts cash into the bond market.
Selling stocks and putting the proceeds into cash over the same period, the data indicated, has generated markedly lower returns.
This month, at least so far, looks set to provide a significant test of the “sell in May” thesis, with the S&P 500 now up 3.7% and within striking distance of its mid-March record, and the Nasdaq advancing 4.87% in the green.
The Dow, of course, is on an eight-session winning streak and has gained more than 4.5%, with the 30-stock average now setting its sights firmly on the 40,000 mark.
Meanwhile, Bank of America's regular Flow Show report notes that $14.8 billion in investor funds flowed into stock portfolios last week, the most since mid-March.
A big move into stocks, and bonds too
Interestingly, the report also notes that bond funds earned their biggest weekly inflow, $17.8 billion, in nearly three years, suggesting that investors' bets on the prospects for fading inflation and slowing growth They will end the idea of a “no landing” for the US economy and trigger a broader rally in fixed income markets.
The Commerce Department's April inflation reading will provide the first data on that trade idea next week. Economists expect a moderate decline in the monthly CPI report, due May 15, as well as a slowdown in overall retail sales.
Related: S&P 500 Aims for Biggest Gain in History of Fed Interest Rate Pause
That said, the University of Michigan's benchmark consumer confidence survey for May showed an uptick in inflation prospects for next year, rising to 3.5% from 3.2% in April. And the Atlanta Fed GDP Now The forecast tool suggests a current quarter growth rate of 4.2%.
None of those readings, of course, suggest the kind of “no-land spike” that would trigger a big fixed-income rally.
“If spending slows and inflation rises, we will get the opposite scenario to what many expected,” he said. Chris Zaccarelli, chief investment officer at Independent Advisor Alliance in Charlotte. “And the Federal Reserve will be in an especially difficult position when it comes to choosing between adapting to a slowing economy and fighting rising inflation expectations.”
A risk worth taking?
And elevated Treasury yields pose a key challenge to stock market returns, according to Comerica Chief Investment Officer John Lynch, in the form of a lower equity risk premium.
This is effectively a measure that estimates the potential gains from holding riskier stocks compared to safe-haven Treasuries.
Taking the current forward price-earnings multiple of the S&P 500, which is about 21 times, and adjusting it for the current 10-year Treasury yield of about 4.5%, generates a risk premium of shares of 0.26 percentage points, the lowest in almost two decades.
Related: The Federal Reserve faces a fine line between inflation hawks and slow growth realists
“History shows that as (the stock risk premium) shrinks, the future return potential for the S&P 500 declines to about half its average gain when the relative advantage of owning stocks is above the ERP trend,” Lynch said.
“Fortunately, corporate earnings have exceeded expectations and, to the extent that forward guidance continues to beat estimates, the 'E' should support the 'P' in the S&P 500 valuation metric,” he added.
Profits, as always, are in the spotlight
That puts a lot of weight on both the end of the first-quarter earnings season, which has about two weeks of top-line reporting to digest, and the start of June quarter updates later this summer.
Data from LSEG suggests that collective first-quarter earnings for the S&P 500 will have risen 7.4% from a year ago to $467.9 billion, an improvement of $5 billion since the start of the reporting season.
Looking at the three months ending in June, LSEG sees the year-over-year growth rate improving to 10.6%, with profits rising to $495 billion on a share-weighted basis.
More economic analysis:
- Beware of 8% mortgage rates
- Hot inflation report hits stocks; this is what happens next
- Inflation report will disappoint markets (and the Federal Reserve)
In the middle, of course, is the Federal Reserve's June policy meeting, which will include new growth and inflation projections (and a new set of dot plots, Fed officials' rate projections). for the second half of the year.
“The Federal Reserve is walking a tightrope as it balances both price stability and growth mandates,” said LPL Financial Chief Economist Jeffrey Roach. “Although it is not our base case, we see increasing risks of stagflation, a concern that markets will have to address, in addition to the impacts of the presidential election.”
Markets are currently forecasting little chance of the Federal Reserve cutting rates before its September meeting, and any upward bias in the new dot plots will likely keep Treasury and ERP yields elevated in their current two-decade lows.
And while that might not be enough to justify the “sell in May” thesis, it leaves stocks poised to see only modest gains over the summer months.
Related: A veteran fund manager picks his favorite stocks for 2024
