"Men in the game are blind to what men looking on see clearly." ~ Chinese Proverb
Although stock prices began the month of May on a mixed note, equities ended the month of April 2020 with their biggest month since 1987. Has the investor herd finally begun to price in the harsh realities of an historic recession to come or will investors continue their seemingly irrational buying binge? It appears as if a clash between two classic investment mantras is set: "Sell in May and go away" versus "this time it's different."
Which will prevail? Here are my thoughts on each, plus a third alternative:
Sell in May and Go Away?
The idea of "sell in May and go away" is that the summer months of trading have historically been the worst months for stocks. Based upon the first trading days in May, starting with a decline of 2.8% on S&P 500, stock investors appear to be finally coming to grips with reality and pricing in the fundamentals they are hearing in recent quarterly earnings reports. Might this continue through the month?
Here's what could make the 'Sell in May' investors right:
- 30 million unemployed and counting: 18% of the labor force is unemployed and the numbers are likely to go up in the short term. For reference, the peak unemployment rate during the Great Depression was 25%. More recently, during the Great Recession of 2007-2009, unemployment peaked at 10%. This recession could come close to depression levels, then remain at "just" extreme recession levels for quite some time.
- Covid-19 treatment and vaccine uncertainty: Although stock prices jumped in April, partially on the hopes of Chloroquine and Remdesivir as game-changing Covid-19 treatments, the former has mixed results and will not be approved by the FDA for C-19. The latter can only be given intravenously (with an IV) and is reserved for those with extreme symptoms. The bottom line is that there's no game-changing treatments out there and it's arguably a gamble to bet that there will be a vaccine within 12 months.
- Too many businesses will not recover: As businesses open back up, many are beginning in a weak financial position and will fail if consumer demand does not soon return to save them. There will be many more businesses than J. Crew filing for bankruptcy.
- Ripple effect of economic pain: A primary reason recessions are rarely brief is that economic pain begets more economic pain, which then erodes at business and consumer confidence. When people are short on money, they naturally spend less. If consumers spend minimally on products and services, the manufacturers and providers of those products also spend minimally, meaning they're not hiring or investing capital for growth. Consumers and businesses are merely holding on for survival. In this environment, unemployment remains at elevated levels and the ripple effects continue.
This Time It's Different: 'Dangerous' or Not?
The legendary investor, Sir John Templeton, once said: "The four most dangerous words of investing are: This time it's different." The idea here is that investors have always been proven, after the fact, to be foolish in assuming that the fundamental rules of investing no longer apply. This foolishness can be either on an extreme bullish side or the extreme bearish side.
The last time the investor crowd thought "this time it's different" (in an extremely bullish way) was during the tech bubble of the late 90s, when investors threw the old fundamentals out the window, rationalizing that the new Information Age and the seemingly limitless possibilities of Internet commerce justified extremely high stock prices. To put it simply, they were terribly and famously wrong.
Here's how the buyers in April could be proven right, thinking that it's different this time, and we won't see a return of the March lows:
The Covid-19 recession is an outlier: This assumes that the March 2020 bear market and the associated recession, as deep as they were, will be the shortest in US history.
There will be a V-shaped recovery: This implies a return to 2019 economic health without any major disruption from this point forward. This would also mean that stocks, as measured by the S&P 500, would need to climb another 18% from current levels and that job losses and the recession would bottom out and begin recovery before the end of 2020 (stock prices are forward-looking between 6 and 9 months).
All or most of consumer activity will return to 2019 levels: This assumes employers will rehire furloughed workers, consumers will return to travel in full force, restaurants will be crowded again and the massive and growing debt levels will be ignored, as people spend like they'll never be unemployed again.
There will be a Covid-19 treatment and/or vaccine soon: While this is possible, it also assumes there will be little or no resurgence of coronavirus cases after the economy opens back up.
Don't Forget About Irrationality
As legendary economist, John Maynard Keynes, said, "Markets can stay irrational longer than you can stay solvent." This is true on the upside and the downside. Investors can keep buying longer than a rational investor might expect. They can also continue selling longer than any rational thought might justify. This should tell you that market timing almost never works. And even though the crowd may be irrational at times, it's not wise to completely move against it.
The "sell in May" mindset seems to be rational but if the Covid-19 bear market and recession are short by historical standards, the April buyers could be proven right: things really are different this time.
But there is a third investor mindset, which is a combination of both: March was a buying opportunity, April was a holding period (not an entry or exit), and the next several months will produce more buying opportunities.
Bottom Line
It's never really different: Stock prices always revert to the mean. Before the coronavirus bear market came along, the US stock market had already completed its longest bull market run in history. The 10-year annualized return on the S&P 500 index was 13.5%. The average, or mean, for stocks is 8-10%, depending upon which historical standard is used. Through the end of April 2020, the 10-year annualized return on the S&P 500 still sat at 11.6%. Put simply, there is more mean reversion to come.
But you don't need to sell in May: For a long-term investor, it's wise to stay invested through all market environments. Remember that 80-90% of gains for stocks occur on less than 10% of trading days. You can't afford to be completely on the sidelines during these days. But a tactical investor may not always remain 100% invested. This investor may remain mostly invested but build cash when the investor herd is irrational on the upside, then use that cash to buy when they are irrational on the downside.
Tactical asset allocation is not "buy low, sell high" in the absolute sense; it's buy some lower, sell some higher, yet remain mostly allocated to core holdings at all times and stay focused on the long term. Always try to take advantage of dollar-cost averaging lower.
If you're not the type of investor that watches markets closely, you may simply make periodic contributions to your investment accounts and rebalance your portfolio on a regular basis.
Most importantly, remember that there are many things in life more important than money.
Be well, my friends.
Kent Thune is a philosopher who happens to be a Certified Financial Planner (TM) and owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC. Mr. Thune is also a freelance writer published on multiple investing and finance websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, The Balance, and The Motley Fool.
