Wednesday, May 20, 2009

The Stock Market: Sell in May and Go Away?

Now they tell us. While a couple of Federal Reserve governors have recently talked about green shoots in the economy and the like, the Fed staff predicted in April that the economy would get worse than expected earlier this year. It's not as bad as W and the WMDs in Iraq, but you'd think that by now senior federal officials would realize it's not a good idea to say one thing when their staff are saying something contrary. After the release of this information, the Dow Jones Industrial Average abruptly dropped about 100 points, from around up 50 to close down 52.

Now that all of us with market exposure have lost some money, the question is what to do. Those with rose tinted glasses would say we just got a buying opportunity. However, there's an old adage in the stock markets: sell in May and go away. It refers to the fact that the market often is flat to negative during the summer months. September can be volatile (either upwards or downwards). October has the deserved reputation as the worst month--not every or even most years. But almost all the big drops since 1929 have occurred in October. No one knows why (and anyone who claims to know is a liar, a fool or both).

Having said all that, there's no way to predict the current market. Stock values right now pretty much depend on governmental policy--the more government intervention, the higher the market goes. That's why the market rose from March 6 through a couple of weeks ago: the federal government fired up a bunch of programs and the Treasury Dept. and the Fed did so-called "stress tests" of the 19 largest banks. There's no major governmental action in the offing, although some of the federal government's programs will probably intensify in the next six months. The underlying economy is in bad shape and getting worse. Some people think it's getting worse at a slower rate than three months ago, and take heart from that. But getting worse is still getting worse. The credit markets are thawing slightly, but only because the federal government has de facto guaranteed the liabilities of the major banks (which comes very close to nationalizing them, although no one in government wants to admit to that). In short, the U.S. economy and the world economy are in bad shape, with no clear sign of recovery any time soon.

The federal government, for all its programs, still hasn't solved the two baseline problems in the financial system--an extremely ill housing market and trillions of dollars of unbooked losses lingering on the books of the banking system. There is no real cure for these problems that's politically feasible (California's voters just rebelled over a state deficit of some tens of billions of dollars, so there's no way America's taxpayers will pony up the trillions needed to cure these baseline problems).

If you invest now, you might be ahead six or twelve months from now. But no responsible adviser would give you assurances about that. You might also be sitting on top of serious losses (especially if the world economy keeps sliding the way it has so far this year). You should be prepared to wait at least ten years for meaningful returns (net of inflation). One way of looking at things is that you could invest today in U.S. Treasury ten-year notes and get about 3.2% (after commissions) per annum for 10 years. Will the stock market return more than 3.2% per annum for the next ten years? Unclear. It's lost close to that much per year during the preceding ten years. Perhaps after ten years, the market will have had a decent chance to show meaningful gains above 3.2% per annum (although we wouldn't predict that). But if you might need the money some time sooner than ten years, you should think about keeping it out of the market and putting it in something safe like U.S. Treasuries. It could take 20-25 years for the stock market to recover, net of inflation, from the current mess. The last time something like this happened, in the early 1970s, the market didn't recover, net of inflation, until about 1991. And the market didn't recover from the 1929-1932 crash until the mid-1950s.

Some people are predicting the Dow could drop to 4,000. While that may seem far fetched, can it be ruled it out? What's already happened is no more far fetched. If you can't stomach the possibility of serious losses on money you invest today, stay out of the market. It's easy to regret the gains you could have had if you had a little more nerve, but it's really hard to recover from the losses you didn't expect. The best financial planning today is to spend less and save more. That generates an immediate increase in your wealth.

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