Should You Sell in May and Go Away?

The stock market is extremely vulnerable to a correction.

At least, that’s what some of the most successful and famous hedge fund managers think.

Take Stanley Druckenmiller, for example. He’s chairman and chief executive officer of the Duquesne Family Office. His hedge fund has generated impressive annualized returns of 30% during his investment career. For that reason, when he speaks, people listen. During his speech at the Sohn Investment Conference earlier this month, he warned investors to be careful about the stock market.

“The conference wants a specific recommendation from me. I guess ‘get out of the stock market’ isn’t clear enough,” he said. He also warned “…the bull market is exhausting itself.”1

He’s not the only one worried about a correction. Carl Icahn, another legendary billionaire investor, said on national TV last month that he’s “extremely cautious” and that the markets “will have a day of reckoning.”2

And he’s backing up that statement with actions. Icahn’s investment fund has a net short position of 149%. This means that the value of his short position is worth 149% more than the value of his long positions. In other words, Icahn is making a big bet the stock market will head lower. During a recent conference call, Keith Cozza, the CEO of Icahn Enterprises explained the large short position, saying: “We’re much more concerned about the market going down 20% than we are it going up 20%.”3

George Soros, another billionaire investor, is also hedging against a market correction. His fund holds a “put” option on an exchange-traded fund that tracks the S&P stock index.4 That option will increase in value if the market drops. This doesn’t necessarily mean Soros is betting on a market collapse. He could just be hedging his portfolio. But this certainly indicates he may be concerned about a correction.

There you have it. Three legendary investors who appear to be preparing for a market correction. Should you do the same?

Four Risk Factors to Consider
Aside from these warnings from legendary investors, it’s also important to consider the seasonal decline in the stock market. After all, stocks tend to perform poorly from May to October. According to the Stock Trader’s Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during that period. In comparison, the stock market has averaged a gain of 7.5% during the November-April period.5 Last year, the S&P 500 suffered an 11% correction during the summer. We could see this historical trend play out once again.

That’s why investors on Wall Street like to say you should “sell in May and go away.” In fact, recent research from analysts at Goldman Sachs indicates that 2016 is a good year to follow that adage. The research warned: “A drawdown during the next few months could find the S&P 500 index falling by 5-10 percent to a level between 1,850 and 1,950.”6

It also pointed out that there are four main factors that could lead to a correction this summer: 1) based on forward P/E ratio, stocks are historically expensive; 2) demand for stocks has been weak, as indicated by the net short position of hedge funds and other institutional investors; 3) the Fed may hike interest rates next month; 4) we’re in an election year, which increases market uncertainty.7

And that brings me to another seasonality effect.

Preparing for a Season of Weakness
Aside from the May-November seasonality, we also have to deal with the election year. Historical data going back to 1928 shows that stocks have lost an average 4% in the final year of two-term presidencies.8 This is exactly what we have this year. President Barack Obama will soon complete his second and final term. And nobody knows who will replace him or what the future President will mean for the stock market. For that reason, things could remain volatile as we head into November.

Does that mean the stock market is doomed this summer? Not really. As you know, anything can happen in the markets. And it’s important to keep in mind that since 1928, there have been only four presidential elections in which the incumbent was ineligible to run again. In other words, we’re talking about a small sample size of just four data sets.9

Nonetheless, I think it’s hard to ignore these seasonality factors and all the warnings from legendary investors. Now may be a good time to become more defensive and prepare for a possible correction. The recent market volatility could be just the beginning of a more significant correction.

Until the next Daily Pfennig® edition…

Mike Meyer
Vice President
EverBank World Markets, a division of EverBank