Selling a wise choice for summer

"Sell in May and Go Away" is an old stock market adage that has appeal in terms of its simplicity and of course the attractions of spending the summer away from busy dealing rooms. Detailed historical statistical analysis of seasonality in stock market returns has tended to produce ambiguous results.

Nevertheless, the prospects for the markets for the first summer of the millennium do look somewhat clouded. The strong bull run enjoyed by share prices through the turn of the century has quickly transformed into a phase of weakness and extremely high volatility.

The sell-off in many of the markets' high-flying shares has meant that much of the speculative froth has been dissipated. The prices of many high-tech shares are now trading at about 50 per cent of their peak levels, while some of the more recent IPO's are up to 60-70 per cent below their peak levels.

For several years now investing in periods such as this has been a winning strategy as markets have subsequently recovered and moved to new highs. However, before investors jump into shares at these levels, there does seem to be reason for greater caution this time around.

One reason for caution is that stock markets still look expensive on the standard valuation yardsticks. The twin pillars that justify these high ratings remain strong sales and profits growth and low interest rates and bond yields.

The prospects for sales and profits growth remains very favourable and recent corporate financial reports have tended to be very upbeat. Therefore, the recent and prospective profit picture would tend to support the argument that now is a good time to invest in the market.

However, it is the prospects for interest rates and bond yields that continue to flash danger signals for the current level of share prices. Interest rates and bond yields have now been rising for the best part of a year. As the table shows, the general level of interest rates and yields remain low by historical standards.

Nevertheless, in an environment of low inflation and high asset prices, small rises in bond yields can have a large impact on the general level of asset prices.

Many commentators have been predicting that interest rates will soon peak around current levels. However, there are increasing signs that rates are likely to continue rising for some time for two key reasons. One is that the US economy is still growing at breakneck speed and the only issue is whether the next rise in official interest rates will be a quarter or a half percentage point.

Second is that the euro's continued weakness shortens the odds that European interest rates will rise much further than currently expected. The beleaguered currency shows no sign of recovering and further falls would almost certainly elicit a response in terms of higher official interest rates. Although equity markets have been able to shrug off the initial phase of rising interest rates, it is doubtful as to whether further rises will be met with equanimity.

The recent phase of share price volatility is bound to have dented investor confidence and therefore the next round of interest rate rises could easily lead to share price weakness. It could well be that selling in May might just be the right strategy for summer 2000.