Market report

Should you sell in May? Companies make more profits than expected, but the economy cools down, the FED model.

May 15, 2024
4 min.
Should you sell in May? Companies make more profits than expected, but the economy cools down, the FED model.

Chart of the week

Source: X, Charlie Bilello, @charliebilello, 03.05.2024

The chart shows two surveys of purchasing managers at companies in the manufacturing sector (ISM Manufacturing PMI) and the service sector (ISM Service PMI). The two indices have historically had great predictive power regarding the future path of the economy and are therefore among the most closely watched leading economic indicators. A value above 50 means a growing economy, a value below 50 means a shrinking economy.
Why this is important
Over the past 15 years, the manufacturing sector's share of total gross national product has steadily declined. It still amounts to 35%. However, the share of the service sector has risen to 65%.

As the chart above shows, the manufacturing industry has been shrinking for 18 months, i.e. in recession. However, the service sector has not. Because of its greater weight, the economy as a whole has continued to grow.

This highlights the analysts' dilemma. Most leading economic indicators are based on manufacturing figures and predict a recession, but the majority of companies are doing extremely well and profits are rising.

YouTube: Mario Lochner, 11.05.2024, Time: 08.13

The chart shows the end of the earnings season for the first quarter of 2024. Earnings rose by 8% on average. An increase of 3% had been expected. The economy is still surprisingly strong and there is no recession in sight.

Source: X, Michael A. Arouet, @MichaelAArouet, 10.05.2024

In contrast to the good earnings season, the US Economic Surprise Index (black line) is falling. The Economic Surprise Index represents the sum of the difference between the official economic results and analysts' forecasts. If the sum is above 0, economic performance generally exceeds market expectations. If the sum is below 0, economic conditions are generally worse than expected.

The index has been falling sharply since the beginning of April. The economy is cooling down. As the chart above shows, interest rates for 10-year bonds (red line) and the USD (green line) have mostly moved relatively in parallel. If this correlation continues, the USD in particular should lose value against the other currencies.
The manufacturing PMI is currently recovering again, but the services sector, which has been a solid support so far, is now starting to weaken. This is currently causing very volatile market movements. Analysts' opinions differ widely. In a situation like this, it is advisable to invest cautiously and not take too many risks.

Should you sell in May?
One of the best-known stock market rules is: “Sell in May and go away, but don't forget to come back in October”.  So it is enough to be invested only from November to April, the rest of the year you can hold 100% cash.

Source:, 25.04.2023

The blue part of the graph shows how an investment of USD 10,000 would have developed since 1957 if you had always been invested from May to October. The red part shows how USD 10,000 would have developed if you had always been invested from November to April. The difference is huge.

There are various reasons why this is the case:

- In the summer months, many are on vacation, volumes are low.
- Companies rarely surprise us with new product announcements. These only come for the Christmas business and are presented in the fall.
- Large service contracts are included in the budget in November and awarded in the spring. There is therefore little new impetus (or positive surprises) from companies.

Over the past 5 years, however, the difference in returns between the two strategies has decreased significantly.

Source: MarketWatch, 01.05.2019

This correlation is examined using data from the last 50 years. The yield difference from May to October (red bars) and November to April (blue bars) was almost 5.5% per year. However, if you only look at the last 5 years, the difference is reduced to around 1%.

The data above comes from the USA. The effect is not equally strong in every country.

YouTube, Finanztip, 16.03.2021

The chart shows in which countries the “sell-in-May” effect is greatest, which tends to be the countries on the right in the chart above. The effect is very high in Switzerland, Germany, Norway and Greece. By contrast, it is low in Finland, Australia and New Zealand. There is no conclusive explanation for the differences.

The fact is, however, that the effect occurs in all countries. There is no country that shows better returns in summer than in winter.

The figures are always average values. If you look at the individual years, the effect occurs in 8 out of 10 years. So it is also a very stable value.

Most of the exceptions in which the effect does not apply in the USA are in election years. We have elections in the USA this year. The reason for this is that candidates make a lot of promises during the election campaign and this provides positive impetus from politicians.

Source: X, Jurrien Timmer, @TimmerFidelity, 10.05.2024

The model owes its name to former FED Chairman Greenspan and Powell, who often referred to this model in their justifications for interest rate decisions. It is not known whether the central bank still actively uses this model today.

The “Fed model” or “Fed Stock Valuation Model” (FSVM) is a theory of stock valuation in which the expected earnings yield of the stock market is compared with the nominal yield of long-term government bonds. The theory states that the stock market as a whole is fairly valued if the expected I/B/E/S earnings yield for one year is equal to the nominal yield on ten-year government bonds.

The black line shows the P/E of government bonds and the red line the P/E of equities. The bars in the lower part show the overvaluation of bonds (in the negative range) or their undervaluation (in the positive range).

From 2003 to 2023, equities were valued at a lower P/E and were therefore the better investment for investors. However, the situation has now changed. Bonds are currently more fairly valued than equities and should therefore have a place in every portfolio.

However, the current situation also has disadvantages. Whenever the bar chart in the lower part of the graph is in positive territory, i.e. bonds are better valued, there is a high correlation with equities. Bonds rise and fall in sync with the equity markets and are no longer diversified.

For this reason, higher volatility in portfolios is to be expected in the coming months and years.

The danger for investors in such a market environment is that they take on too much risk because equities and bonds no longer complement each other as well as they did in the past 20 years.

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