A quick detour from bashing corrupt politicians: Sell in May and go away.

Those that know me from the financial boards know that I was 100% in Ginnies in my retirement account back in the fall of 2008 when the markets began to crater along with the near collapse of our financial system. Of course when I perceived an opportunity in early 2008 to buy back into equities, I was all over it, indexing the market and overweighting certain sectors I thought would do well on the way back up. I am pleased to report I consider that mission accomplished to my personal satisfaction.

But there is also an old Wallstreet saying, “sell in May and go away”. It refers to the historical fact that the market performs best from December to May while most of the spectacular crashes have occured in the June to November time period with an overweight on big declines beginning in the months of September/October.

Toby over at Greenbacked wrote a post last Friday that highlighted a post on the DShort blog which analyzes current market valuations using the Ben Graham’s PE10 which is an excellent read, especially for you lay people that self direct your own 401k accounts. Lets begin at DShort:

Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market’s value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by the 10-year average of earnings, which we’ll call the P/E10. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the P/E10 to a wider audience of investors. As the accompanying chart illustrates, this ratio closely tracks the real (inflation-adjusted) price of the S&P Composite. The historic P/E10 average is 16.3.

Toby adds some excellent analysis for the Greenbackd nation:

So what is the P/E10 ratio now saying about the market? In short, the market is expensive. The ratio has entered the most expensive quintile, which means it is more expensive than it has been 80% of the time.

There are several implications associated with this as Toby notes, including the fact that those who put their money in the market (as a whole) at this price level can expect a 1.7% ten year return. A saving grace can come in the form of increased corporate earnings but I consider it unlikely because all else being equal, earnings would have to rise 34% to revert the PE10 to its historical mean. There are still too many excesses in the economy for that to happen IMHO.

Also, for those of you like minded folks that think long term, depending on who is giving the number the current secular bear market is around half passed. I’d link the term “secular market” but frankly I thought both the investopedia and wiki definitions stunk. In broad terms an informed layman can understand, within each megatrend there are cyclical or short term trends thus the zip zagging nature of a typical stock chart as illustrated by this 3 year chart I printed for Allstate Corp:

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That dangling March 2009 low tells me there will be another significant correction before things can get materially better over at the house that Tom Wilson is burning down. And sorry ALL longs there is no golden cross as both averages must be trending up when they cross. That said there is money to be made in them zigs and zags, both at the individual issue level and in the broader indexes.


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