"Sell in May"+Elections=toxic JSE cocktail

2014-04-23 11:45

Every May month results in a flood of "Sell in May and go away" articles in the press. The premise is that the period of June through to October has far worse stock market returns than normal. Whilst it is true that most major stock market crashes have occurred during this period, the blind interpretation of this theory every May is not the right approach.

In fact there is a far stronger relationship between the "Sell in May" theory and the American Presidential four-year (quadrennial) election cycle. In fact, you should only "Sell in May" every four years, in the mid-term election year, as opposed to every year. This is a far more intelligent interpretation of following a seasonal stock market strategy as it has a major impact on the U.S markets and hence the JSE.

Local investors are usually very surprised to hear that election cycles in the U.S have so much impact on the JSE, but it is true - in fact U.S elections cycles have a larger impact on the JSE than our own election cycles - something to ponder upon as we stand in voting queues on 7th May!

The U.S Presidential Election Cycle stock-market model is a theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the mid-term year. The course of important US markets is largely dependent on whether the current year is an election year or one of the three cycle years following an election. Stocks tend to see an above average increase during the year preceding an election year.

The reasons given for this development are numerous and well documented, but the strongest is assumed to be economic policy before an election. Increasing stock prices and a booming economy sheds positive light on the incumbent political party, so the purse strings are opened wide. But not only stocks are influenced by the US election cycle. Interest rates and currencies can also be affected. Through the dominance of the US capital markets, international markets (such as the JSE) are also influenced by the election cycle.

The chart below (just click for larger view) shows the average cumulative return on $1 invested in the SP-500 through the first two election-cycle years and the first 9 months of the 3rd year - for fourteen 4-year cycles stretching back to the early 1950's. We compare this to the returns of $1 invested in the SP-500 for the current 4-year cycle that commenced in January 2012 (the pink line): We note that the current progress of the SP-500 returns (pink line) for the last 28 months has had a better than 98% correlation to the expected historical return profile of the Presidential Cycle model (the black line), with the last 7 months being 100% accurate to the directional playbook and the last 21 months only reading 2 months directionally wrong (90.47% accuracy) The record for the SP-500 for May through to September in the Mid-Term election period does not look endearing at all, in fact it is downright dismal. Looking at the above chart, you cannot be blamed for every fiber in your body telling you the SP-500 has already commenced her mid-term rollover.

The risk versus reward expectations for the April though September period on the Quadrennial Presidential Election cycle model are tabulated below (click for larger view):

Whilst it is not impossible for out-sized gains to occur during this period, the odds are clearly stacked against you with the historical record providing a lowly 35% chance of success and losing points outweighing winning points by 2.56 times to one. If you are purely making decisions on statistical odds of past performance then this is the time to be sitting out the market since risks are more than double any likely rewards.

At PowerStocks Research, we track a similar cyclical model for the JSE for our subscribers called the SuperCycle Seasonal JSE Model and it is most certainly selling in May. Not every year, but certainly this year. The Latin phrase “caveat emptor” (let the buyer beware) comes to mind.

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