Globe and Mail business writer Jennifer Dowty, c. June 15, 2015. Credit: The Globe and MailThe Globe and Mail
Equity markets may be in for a summer rally if history repeats itself.
A popular investment adage is "Sell in May and go away"; however, this approach may not be the most effective investment strategy. Historical performance, investor sentiment and earnings preannouncements, among other factors, all suggest that North American equity markets may perform quite well this summer.
Looking back to 2005, the S&P/TSX composite index has delivered positive price returns, not including dividends, for seven of those 11 years. The exception years were 2015, 2011, 2008 and 2007. Last summer, concerns about China and global growth dominated the headlines and investors headed for the exit doors. In 2011, the European debt crisis caused a meltdown in equity markets, and back in 2008 and 2007, Canadian economic growth slowed with the country's economy falling into a recession.
Outside of these four negative years, during the other seven the S&P/TSX composite index not only realized positive price returns, but strong gains, rising between 3 per cent and nearly 8 per cent over the two summer months.
On Wednesday, the Bank of Canada releases its quarterly Monetary Policy Report. In last quarter's report, real GDP was forecast to grow 1.7 per cent in 2016, rising to 2.3 per cent in 2017.
Recent U.S. data, such as last week's U.S. non-farm payroll figures, suggest the U.S. economy is not headed for a recession.
The underlying North American economic conditions do not appear to be at risk of derailing the current positive market momentum.
Furthermore, investor sentiment is in neutral territory. Research provider Investors Intelligence conducts sentiment surveys that are useful contrarian indicators. For instance, when there is excessive optimism with the percentage of bullish financial advisers above 60 per cent and the percentage of bearish advisers below 20 per cent, this may indicate a peak in equity markets, and be a warning signal for investors to sell stocks. As of July 5, the survey reported 47.1 per cent of advisers were in the bullish camp and 24.5 per cent in the bearish camp. In other words, there does not appear to be excessive enthusiasm driving markets higher. To the contrary, the positive market momentum resembles more of a cautious optimism, with investors seeking growth and income.
With further U.S. Fed rate-hike concerns on hold, Brexit worries waning and oil prices that appear to have stabilized, investors can shift their attentions to earnings.
On Monday, the U.S. second-quarter earnings season kicked off on a positive note with Alcoa reporting better-than-expected results.
Turning to earnings preannouncement, according to the FactSet Earnings Insight report dated July 8, the percentage of companies in the S&P 500 index issuing negative earnings guidance is narrowly below the five-year average – a potentially positive sign for the reporting season.
Over all, the prevailing backdrop seems to bode well for North American equity markets, at least in the near-term.
For now, it appears that both the "risk on" trade, with cyclical stocks rebounding, combined with the "risk off" trade, with defensive, income securities continuing to remain in high demand and rising, are each shaping up to be solid investments for investors.
Looking at sector returns over the summer months back to 2005, sectors realizing positive returns with the greatest frequency were a combination of cyclical and defensive sectors. The materials sector has delivered positive price returns during nine of the past 11 years, or more than 80 per cent of the time. This sector declined during two years, in 2015 and in 2008. The technology sector was also strong, realizing positive returns during nine of the past 11 years. But the leader was a defensive sector, telecom, rising 10 of the past 11 years.
All this being said, a major headwind to a summer rally are valuations, with many stocks trading at high valuations relative to their historical levels.
Yet, for now, the trend is your friend, and North American equity markets appear to be set on climbing a wall of worry – at least in the near-term. A barbell strategy – which is a mix of cyclical stocks and defensive stocks – appears to remain an optimal asset-allocation strategy to minimize risk and maximize returns.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.
Jennifer Dowty