Global Agenda: Sell in May...

Financial markets have seen more bad days in the last two weeks than in the past several months.

Of all the well-known pieces of market lore, the adage to “sell in May and go away” is one of the most often quoted – in Europe as in the US (including in this column) – and one of the most useful, because it so often proves to be correct.
The entire phenomenon of seasonality in stock markets remains something of a mystery, despite endless attempts to suggest logical (or other) reasons to explain it. But the fact remains that, more often than not, the early and late months of the calendar year tend to be positive and the middle ones much less so; put another way, the winter months, November through April, are when most markets do most of their rising, and the summer months, May through October, are when they do most of their declining.
There are, of course, exceptions to this “rule.” The collapse of 2008 began well before May, actually took a break in the summer and then returned with a vengeance in September-October. The traditional year-end rally did indeed take place, so that the pattern was not entirely voided, but 2009 did not follow the book at all. The opening months were terrible, but the rally that started in March stretched through the summer.
Last year was more of a textbook year, with the positive winter months giving way to a sharp decline in the early summer and subsequent weakness through the hot months. The rally restarted in September, which missed its cue as the worst month of the year, and then continued almost without a pause – until the end of April.
Now here we are in mid-May and it is safe to say that markets – not just equity markets but virtually all the financial markets all around the world – have seen more bad days in the last two weeks than in the past several months. Indeed, it is the degree to which that theme is so common – across supposedly disparate markets, countries and asset classes – that gives this current downturn its ominous tone. That and the stream of negative economic news that is another common theme around the world.
In fact, once you focus on the “key words” that characterize economic commentary concerning most countries, irrespective of size, location or governmental system, it’s easy to see what’s bugging speculators and even longer-term investors. The first of these key words is inflation, which is measured and reported on regularly and everywhere – and is on the rise everywhere.
This is bad news for a number of reasons:
• First, it has a negative impact on corporate profits, because the prices of most companies’ inputs are rising much faster than they can pass on these higher costs.
• Second, in all countries operating within a framework of normal economic policy (which nowadays means the developing world but not North America, Western Europe or, of course, Japan), higher inflation has led to rising interest rates, which have a negative impact on riskier investments, including equities.
• Third, since wages in most developed countries are not rising, inflation erodes the purchasing power of most households’ income, which forces them to buy less of everything except “essential goods” such as food, heating and travel – the very items whose prices have risen most.
This combination of negative consequences raises the specter of “stagflation,” a nasty economic disease that was prevalent in the 1970s and caused much distress then. Stagflation means that growth is stagnating, but prices are rising. It is one of the worst situations an advanced economy can find itself in, because virtually nobody comes out ahead. Most companies, most households and even the government are caught in a vice of rising costs and declining revenues.
Eventually, one side of the equation gets the upper hand – either the “stag” bit wins out, and there is a recession that gets the “flation” bit under control, but at a high social and economic cost; or the “flation” bit gets the upper hand and drives an increase in economic activity. But in an inflationary situation, that means that everyone runs faster just to stay in the same place, and the inevitable result is a slump.
In short, stagflation implies that you suffer from both recession and inflation, at first together but then in sequence. The specific economic policies that different governments adopt can determine which order the sequence goes in, but they cannot change the ultimate outcome.
That is why the prospect – and the increasing evidence of the reality – of a stagflationary economic environment taking hold everywhere from Beijing to Brussels is generating so much concern. And that concern is, inevitably, finding its strongest expression in the financial markets – as usual, in May.

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