Markets have fluctuated in recent months but whether this will continue remains to be seen
Stockmarkets exhibit a striking degree of seasonality. “Sell in May and go away” sounds like a superstition but patterns in decades of stockmarket data show that there is some underlying truth to it. A mechanical approach that sold everything in May would not be advisable as in some years markets are strong but, as chart 1 shows, on average since 1973 an astounding 97 per cent of global stockmarket returns have accrued during the seven months from October to April.
The summer holiday period seems often to be directionless for markets as trading can be thin and economic data is less meaningful. Volatility tends to reach its peak in October; a fact underlined by famous October crashes in 1929, 1987 and 2008.
We expected this October to be choppy and it was. There are serious cross currents in the world economy. US growth has been strong but this means interest rates are rising to head off inflation. Meanwhile, in China and Europe things have been slowing down markedly.
Add in trade wars, eurozone stress triggered by the election of a populist government in Italy and Brexit uncertainty and you have a pretty toxic mix. Stock prices fell sharply over the month.
It often pays to be fearful when others are greedy, and greedy when others are fearful. We monitor a proprietary indicator of investment sentiment that includes measures of stockmarket volatility, surveys of private investor bullishness and a metric showing the degree to which company directors are buying shares in their own companies.
Markets are volatile, investors are bearish and US company directors are strong buyers, moving our indicator to one of its most depressed readings on record (seen in chart 2). Only the Lehman failure in 2008, the euro crisis in 2011 and the China devaluation panic of summer 2015 compare to it.
Our view on equity exposure in multi-asset funds has evolved as the year has progressed. We bought stocks aggressively during market weakness in the first months of the year and then moved back to a neutral position in the early summer, particularly reducing emerging market exposure. Our caution was underlined by the Investment Clock model that we use to link asset allocation decisions to the global business cycle.
For the past few months it has been in stagflation with global growth slowing but inflation rising. This can be a bad time for stocks as earnings forecasts come under downward pressure but inflationary pressures see interest rates rise.
Equity investors would like the Federal Reserve to cut US interest rates to restore a positive tone to the markets but it is a long way from doing that. President Trump’s decision to blame the Fed for market weakness complicated matters as it made it less likely that it would cut rates or even signal a pause ahead of November’s mid-term elections for fear of being accused of giving in to political pressure.
We are very much aware of the short-term risks but have been buying the dip again over October as longer-term fundamentals are still positive. We expect the US economy to remain strong in 2019 with tax cuts and spending increases feeding through. US interest rates are very low and low inflation means the Fed is not trying to squeeze growth out of the system and may pause its rate hikes once the elections are out of the way. It is only, at present, trying to get policy to a neutral setting and there is a high degree of uncertainty as to where neutral is. Meanwhile, in China, policy is being eased on an almost daily basis with rate cuts, moves to free up bank reserves to increase lending and tax cuts.
A good US earnings season may be the driver of more positive markets into the end of the year. A more conciliatory mood on trade tensions would also help. To complete the saying, sell in May and go away, come back St Leger day. Markets could remain volatile for a while but investors will probably see the glass as half full before too long, especially if Chinese stimulus measures start to feed through.
There’s another saying in the markets that may be of help: investors can stop panicking when policymakers start to panic.
Trevor Greetham is head of multi-asset at Royal London Asset Management