Sell in May and Go Away: Why Stocks Could Be Headed Lower Very Soon

The Dow and U.S. stock markets stabilized last week, as investors sat tight amid the continuation of corporate earnings season. If history is any indication, the market could be peaking at the wrong time now that the so-called Halloween Indicator has run its course.

Sell in May and Go Away

The Halloween Indicator is an investment strategy that tells investors to load up on stocks from November to April – a period known fro generating higher than average returns. This leads to the old adage ‘sell in May and go away,’ which warns investors to exit the stock market to avoid a seasonal downdraft.

Stocks have nearly recovered last year’s peak just before a devastating market collapse dragged the S&P 500 and Nasdaq into bear market territory. While a repeat of Q4 is unlikely at this point, there are several top-down macro risks that could exacerbate the seasonal selling period.

One of the biggest risks is the massive surge in U.S. corporate bond issuance in recent years. By 2019, a total of $9.1 trillion worth of U.S. corporate debt had been issued. That accounts for nearly 47% of gross domestic product. A lot of this debt is rated triple-B and most of it could be considered junk status. Most of this debt is set to mature over the next half decade.

Secondly, the $1.3 trillion leveraged loan market is double what it was in the year of the financial crisis. Roughly 90% is issued by non-banks, which don’t have the same investor protections as the major financial institutions.

Meanwhile, ultra-loose monetary policy and huge amounts of liquidity in global markets is pushing valuations higher regardless of fundamentals. As The Globe and Mail notes, many mergers now take place at 12-14 times earnings before interest, taxes, depreciation and amortization (EBITDA), well above the average of 11.

As Hacked mentioned a few months ago, the S&P 500 Index is significantly overvalued anywhere north of 2,800. As the benchmark index continues to push north of 2,900, its trailing price-to-earnings ratio is more than two points higher than the long-term average.

Against the backdrop of a slowing global economy, these risks could set off a bearish reversal in the not-too-distant future. This means higher volatility, bigger price swings and a sizable drop from current levels.

S&P 500: An Update

The large-cap S&P 500 Index rose 0.2% on Thursday to close at 2,905.03. Earlier in the week, it had peaked at 2,907.42, less than 20 points away from a new all-time high.

Rising stocks have been accompanied by a sharp drop in expected volatility, which is conveyed by the CBOE VIX. The so-called “fear index” is down more than 52% this year and is trading at roughly half of its historical mean. Most of the time, VIX falls when stocks rise.

The following chart highlights the inverse relationship between the S&P 500 and CBOE VIX, which is observed 75-80% of the time. | Chart via Stockcharts.com.

Corporate earnings could the market’s biggest influence next week. On Monday, eBay Inc. (EBAY), Lockheed Martin Corp (LMT), Verizon Communications Inc. (VZ) and Snap Inc. (SNAP) are set to report.

Reporting on Tuesday are Dow blue chips Caterpillar Inc. (CAT) and Microsoft Corp (MSFT). Facebook Inc. (FB) is also scheduled ot release its quarterly earnings report.

Featured image courtesy of Shutterstock. Chart via Stockcharts.com. 

Author:
Chief Editor to Hacked.com and Contributor to CCN.com, Sam Bourgi has spent the past nine years focused on economics, markets and cryptocurrencies. His work has been featured in and cited by some of the world's leading newscasts, including Barron's, CBOE and Forbes. Avid crypto watchers and those with a libertarian persuasion can follow him on twitter at @hsbourgi