Sell in May and go away is an adage that warns investors to sell their holdings to avoid a seasonal decline in the stock market. This adage doesn’t hold water from a statistical standpoint. However, this isn’t a typical year.
The S&P 500 is up a hefty 11.8% year-on-year. More importantly, this move has made stocks overvalued. For instance, the trailing price-to-earnings ratio for the S&P 500 as a whole stands at 24.7-times earnings. That’s a hefty 57% above the historical average.
Similarly, the trailing price-to-sales earnings for the S&P 500 is at 2.2-times. That’s 49% above the historical average.
Price-to-sales chart for the S&P 500
The stock market is heading into May steeply overvalued. High valuations tend to make investors skittish and more likely to sell at the first sign of trouble.
Volatility is making a scary comeback
Last year, stock market volatility was exceptionally low. The CBOE Volatility Index (VIX) measure spent most of last year hugging 10 and only twice briefly peaked above 15.
Generally speaking, the market is complacent when the VIX drops below 20 over a sustained time period. So we had an exceptional and unusual run last year which may have been driven by investor complacency.
Similarly, a VIX reading near 30 is a sign of substantial investor fear and uncertainty. At the start of February, the VIX surged to 29. That was the highest reading since 2011.
Surging volatility is the clearest indicator that investors are starting to become more fearful. And this makes sense intuitively.
Fund managers sitting on large gains on over-valued stocks don’t want to risk their gains to grind out a little more money. Moreover, there aren’t any major economic catalysts, like more tax cuts, on the horizon to drive markets higher. So investors are selling whenever any uncertain event arises.
Fear the Fed, Sell in May and Go Away
The Federal Reserve (Fed) is in the process of tightening monetary policy. Indeed, the Fed has already increased interest rates six times to 1.75%. They have also announced plans to raise another five times over the next year and a half.
This is a problem for the stock market and the economy. Rising interest rates tend to choke off spending by consumers and businesses. That’s because higher interest rate expense siphons off money that would otherwise create more demand for products and services or go into the stock market.
Indeed, most recessions that have taken place in the last fifty years have been preceded by rising interest rates. Bonus report: Sign up to get a free report on how to make money off of rising interest rates!
On top of that, the Fed is also draining tens of billions of dollars out of the debt market right now. Its plan is to ramp up to about $50 billion monthly by October of this year.
The Fed plans on taking $50 billion out every month for years. Indeed, it will eventually take anywhere from$1.2 to $2.4 trillion out of circulation.
That means financial markets are now bleeding out a lot of money. This will eventually start hurting stock valuations and pull the market down. In conclusion, sell in May and go away adage is a relic but it is also good advice for this summer.