Is There A Bear Out There?

Earl Berger Ph.D. (Econ.)

Every year about this time, the media is filled with articles about going away in May and coming back in October. The idea is that stock markets tend to decline during the spring and summer.  The reasons for this phenomena are not clear: perhaps the rich folk who trade are away on holiday; or the mutual funds and the retail investors have already made the bulk of their RSP and IRA investments for the year; or the year end bonus has been spent, or a combination of all these reasons. Whatever the reasons, this is the time of year when we are likely to come across advice to ‘rebalance’ and to ‘lock in profits’. Personally, I oppose selling shares in perfectly well functioning companies which turn a decent profit, paying capital gains tax on the transaction, and then buying back the shares or looking for another attractive investment. So, what is the bewildered and ever anxious retail investor to do? Perhaps just take a deep breath and concentrate on the long term.

On the bright side, the old saw about the period May to October may not necessarily be true. The New York Times found that, going back as far to 1945, during the May-October period the S&P 500 gained on average about 1.6%. In contrast, during the November-April period the average gain was about 7.1%. So there is a difference, on average, between the two periods; however, a 1.6% increase is better than a decrease.

But these are averages, and averages often hide substantial variations in stock and index prices. For example in 2006, according to the Times, the S&P 500 gained 5.1% during the May-October period. More significantly, during the 61 years since 1945, the May-October period has outperformed the November-April period approximately one year out of three.

To make matters more confusing, data show that July and August are some of the best months of the year – a finding which astounded this writer who recalls a particularly awful August when he wished that he had kept his money in government bonds. And to show you how wrong your gut feelings can be, since 1998 October has been one of the better months of the year – again, on average. To confuse matters even more, a more detailed analysis shows that since 1990, eight of the 10 sectors in the S&P 500 have posted positive returns during the May-October period.

There is, however, the longer-term perspective which suggests we may be in for an unpleasant time. Our friend Steven Whiteside notes that we are seeing metrics not seen since the Great Depression. On Sunday April 29^th he noted that the Dow has advanced in 19 of the past 21 sessions and this has happened only twice in the past 100 years: once in 1927 when the market subsequently dropped, advanced a bit to a high point in 1929 and then dropped significantly again followed by the great crash of 1929.  So far, he noted, we have had only minor pullbacks from these continuing highs, some lasting less than a day, and there has not been a strong negative signal.

The markets have advanced considerably since Steven’s warnings on April 29^th and in this week’s note (May 6^th) he pointed to China, which has a volatile stock market, and is exhibiting rapid speculative  growth and has a chart pattern which appears “overbought”. For someone who watches his stock portfolio more frequently than necessary any references to the 1929 crash make me very nervous, quite apart from worrying about a seasonal effect.

As we settle into the smoggy days of spring and summer, we should keep several things in mind. There are record amounts of cash sloshing about looking for a home, and the US presidential election campaign is underway. Both events encourage inflation, binge spending for companies and high prices for stocks.

Economies in Asia, eastern Europe, Latin America, and even in some African countries, are growing at about 8% a year – this rate likely cannot be sustained over many more years, something we will discuss in our next column. In the meantime, the demand in these countries, and in the developed world, for energy, new infrastructure and consumer goods is likely to continue. Even in Europe, supposedly lumbered with rigid labour and economic restrictions, the rates of growth are healthy; and who knows what Sarkozy will bring to France.

What to do? Hold your breath and your positions until there is a solid weekly sell signal, sell your laggards, and then wait for the solid buy signal that surely will follow. Keep in mind another axiom, “you cannot make money in the stock market if you are not in the market”.

Earl Berger graduated from the London School of Economics, has traveled and worked in the Middle East and Africa and is always looking for interesting investment opportunities. He was assisted in preparing this column by David Trost BASc., P. Eng., who has been senior vice president of a large mutual fund company.