Where Next For The Stock Market?

September 14, 2009

david Kuo-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

It wasn’t supposed to happen. Shares were not supposed to rise between May and September. That is if you believe the old stock market adage that says you should sell in May and go away, and don’t come back until St Legers Day.

However, if you had heeded the advice this year, you would have missed a 13 percent jump in shares during the summer months. Other great times to have ignored the adage were in 1987, 1997 and 2005 when shares jumped 15 percent, 18 percent and 14 percent.

But before we dismiss the adage entirely, there appears to be some grain of truth to the quaint saying that has its roots in London’s sewers rather than London’s financial district.

The five months from May to September have not been rewarding for private investors in twelve out of the last 25 years. By following the advice, investors would have sidestepped the severe stock market falls of 2008, 2002, and 2001, when shares fell 19.5 percent, 28 percent and 17.8 percent respectively.

Additionally, selling your shares in May 1998 would have protected your portfolio from the collapse of Long Term Capital Management, which saw shares crumble almost 15 percent during the five summer months.

Selling your shares this year would not have been clever, though. The London market has climbed 13 percent between May and the start of September. The summer surge accounted for almost all of the stock market gains to date this year.

Of course, if you stare hard enough at any set of data a pattern will eventually emerge. It may not mean anything useful, but it is a pattern nonetheless.

On the face of it, the summer months do not appear to be the best time to hold shares. The London stock market has risen around 8 percent a year between 1984 and 2008. By comparison, shares have fallen around 0.7 percent during the summer months of May through to September. Therefore, selling in May and buying back in September could be marginally beneficial.

However, it is important to consider other factors before you liquidate your portfolio at the start of every summer. It is essential to take into account selling and buying costs of around 3 percent of your portfolio value. Then there is Capital Gains Tax to pay if your gains exceed the current allowance of 9,600 pounds. And don’t forget you will have to forgo your dividends too.

So where next for shares? Should we liquidate our portfolios and lock in the gains for this year?
Truth is shares were ostensibly cheap following the sell-off in 2007. Consequently, the rebound was not unexpected even if it did happen in the summer of 2008. However, the speed and magnitude of the recovery did take many by surprise. And now that the low-hanging fruits have been plucked, peeled and baked into a pie the next stage will be more tricky.

The economic recovery, which is likely to take years, could be slow and anaemic. High levels of corporate failures will be a key feature as undercapitalised and highly indebted businesses find it increasingly difficult to secure finance. Consumer spending will remain subdued as shoppers keep their spending belts tightened. The upshot is a torrid time for many businesses.

The trick for investors now is to find companies with strong balance sheets and manageable debt that will benefit from any economic recovery. These companies do exists and their growth should spur the next stage of the stock market recovery, which may not occur overnight, but will happen over time.

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