Sell in May and go away 2012?

By David Andrews | May 4, 2012 | Last updated on May 4, 2012
5 min read

The old Wall Street mantra has worked pretty well in the last couple of years but the jury is still out if you go back a few more years. That said, investors seemed to think we are in for a three-peat based on their reaction to news this week. It’s still early in the new month, but there are increasing questions about the strength of the U.S. economic recovery, ongoing questions about the health of the Chinese economy, and of course the endless problems in Europe. Stocks and commodities finished the week lower.

Perhaps the biggest frustration for investors is the modest pace of economic growth the data is currently suggesting. Lately, the results have been neither too hot (which would have the economy on a higher trajectory) nor has the data been coming in too cold (suggesting another round of stimulus is imminent). So our patience is tested and we wait.

The new month got off to a pretty decent start with the posting of better than expected Chinese PMI and U.S. Manufacturing from April, but enthusiasm soon waned as a steady stream of weaker economic data out of Europe and an anemic U.S. monthly payrolls report where only 115,000 new positions added versus 160,000 forecasted. While the April jobs data was generally weak, it may not be weak enough for investors to see any immediate action from the Federal Reserve. We suspect that if the May payrolls are also disappointing, the odds will increase in seeing some policy action at the Fed’s June 20th meeting.

Europe is on our minds again as Spain confirmed it was the latest euro zone sovereign to re-enter recession. The news was greeted with a credit rating cut to eleven Spanish banks following last week’s two notch downgrade of Spain’s short- and long-term ratings. The ECB held interest rates steady as expected but the dovish comments from the ECB chief suggests European economies worsened in April. Stimulus measures have not had a lasting impact on the economy and austerity measures are now crimping growth, even in Germany.

In corporate news, the much anticipated Facebook IPO expects investors to pay as much as 99x earnings as the company seeks as much as $96 billion in an offering expected May 17th. The company would be trading at a higher multiple of earnings than every member of the S&P500 except


Canadians have come to rely on housing wealth to the extent that housing—construction, renovation, and ownership costs—now makes up over 20% of Canada’s GDP. Finance Minister Flaherty and Bank of Canada Governor Carney have both repeatedly voiced concerns that household spending is being fed by borrowing at low rates against high house prices. Income growth, which has been weak, has been increasingly offset by debt backed by elevated real estate values. Perhaps most interesting, in a recent poll of Canadian retirees aged 60-69, one quarter of those that own their own homes still have a mortgage on the property. Those on fixed incomes may find higher payments difficult when interest rates rise.


Investor sentiment is already in a weakened state, and for most of next week the market’s direction will likely be determined by the outcome of a series of elections being held across Europe this weekend. The key votes are in France, where polls show François Hollande appearing to be headed to victory over incumbent Nicolas Sarkozy, and in Greece, where there is no clear front runner and the likelihood of another coalition remains high. Voters are expected to show their displeasure over the rising taxes, high unemployment, and little opportunity. Some of the election results are already priced in, but what the victors do or say regarding Europe’s austerity drive and the fiscal compact will likely influence how global markets kick off the week.

U.S earnings season has essentially concluded but results from Disney and Cisco Systems could be influential. Disney is expected to take a $200 million hit on its John Carter movie flop but consensus estimates are for 10% growth versus Q2 last year. Cisco Systems has done well in managing the street’s expectations, so there could be some earnings upside when they report next week. Corporate Canada continues to report quarterly profit numbers in earnest next week with results from Tim Hortons, Magna, and SunLife Financial expected. So far, Canadian earnings have been mostly mixed with the variability in commodities prices causing most of the earnings volatility reported thus far.

On the economy, the key releases are Canada’s Employment report for April and the U.S. Trade Balance, weekly jobless claims and April Producer Price Index. Canada’s job picture is likely to underwhelm since the U.S. report will already be a week old when Canada announces its employment situation. The U.S. trade balance is expected to widen in March due to the diverging growth among major economies, with the U.S. outperforming of late. More specifically, oil imports could be a big swing factor as petroleum prices increased over 4% on the month. Following the April non-farm payroll report, next week’s jobless claims should continue the trend of moving higher. April PPI should fall for the first time in six months due to lower energy and food prices.


Will the April Employment Report be the tipping point for stocks?

We have long argued that the true gauge of the sustainability of the economic recovery can be measured in both employment and housing. Since housing is really just an extension of the jobs market, if the employment situation were to remain weak, the consumer-driven U.S. economy will continue to sputter. In turn, that will negatively affect earnings and share prices will adjust. For April, the headline nonfarm payroll number was 115,000 new positions. Private employment increased by 119,000 which was the smallest gain in seven months.

Payrolls need to grow at 200,000 or better since anything below that level has been historically negative for equities. After troughing in mid-2009, monthly payroll growth turned positive again in early 2010 and the job market appeared to be stabilizing The equity market also began to strengthen, rallying significantly throughout 2010 and early 2011. Payroll growth then dropped below 200,000 in May of 2011 and stayed below that level for seven consecutive months. The S&P 500 was down over 18% from its peak to trough over that same period. If the recent payroll report is the start of a new trend, equities could be in trouble in the coming months. Investors should continue to monitor the employment market very closely and consider hedging their equity positions and/or diversifying into asset classes that will perform better in a “risk off” environment like bonds and precious metals.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP

David Andrews