Sell in May and go away? Not this year

19th May 2010

This is a time to keep the faith and not get panicked by temporary market turbulence, according to the experts.

Alec Letchfield, the head of equities at HSBC Global Asset Management, insists the old maxim about selling in May and going away is simply not going to apply this year.

Instead, he says, the spring's share price slide was just the London market pausing for breath while it assimilated a whole string of exceptionally solid economic results that haven't really been in evidence anywhere else in Europe.

Not many other countries are making 2% GDP growth at the moment, he says. And very few have the kind of corporate profitability that we're now seeing in Britain.

Our forward price/earnings ratios are only around 12, which puts them in bargain territory, both historically and geographically.

The market had got ahead of itself by the spring, and it needed the correction to reposition itself.

Letchfield agrees that the prospect of a hung parliament was certainly a trigger for the share panic in April and May.

("The question was, are we going to have the political mandate for tackling Britain's terrible deficits?")

And that the threat of contagion from the euro crisis was a further worry.

But that the formation of David Cameron's coalition government on 11 May, combined with the EU's €750 billion rescue package for the euro zone, have answered these major concerns.

It's a time to keep your nerve, he says.

The blessed power of hindsight

If only we'd known that this spring's 12% share price fall was going to be over so fast.

We'd have remortgaged our homes and pumped every penny we had into the stock market while Mr Clegg and Mr Cameron were still deep in their post-election talks, and that nice Mrs Merkel was trying to persuade the German voters they ought to support the bail-out that would stop the Greeks from burying the euro.

Just think how much money we could all have made if we'd only managed to get our timing right when it really mattered?

Except that we wouldn't have, of course.

By the time the Footsie eventually made its soaring recovery back from the depths of despair in mid-May, most of us were just too relieved by the turnaround to do anything more than to mop our bloodied brows, groan a bit, and carry on as before.

The companies in my own portfolio were still the same old companies as ever, still selling to the same people and making just the same profits as before the panic.

Which was fine by me, because I do like stability.

But exactly what is it that knocks all those noughts off the stock market for a few days and then puts them all back on again?

And is there any way we can harness the insanity to make some proper money?

Fear and greed

We need to start by remembering that greed and fear are the two biggest driving forces of all. And in a price panic, it's fear that suddenly becomes dominant.

Your average fund manager is suddenly faced with the prospect of losing a lot of his clients' money unless he acts fast.

He probably hasn't got time to research the true fundamentals of the situation and sift out the pearls from the mudslide.

So what does he do?

The same as everybody else, of course. He sells before prices can fall any further. 

Nobody wants to be remembered as the one who didn't reac fast enough.

And then, when the fear's over, it'll be back to greed again, and he might be in with a chance of buying it all back more cheaply.

Well, that's what he hopes anyway.

That's herd behaviour for you.

The curse of bad logic

But there's also simple ignorance.

When the pressure's on, people make stupid mistakes that have hefty consequences.

American investors are rather prone to dumping Lloyds Banking Group shares whenever they hear on the TV that there's been some kind of a problem with the Lloyd's insurance market.

Different punctuation, different name, different business, but heck, it sounds the same, so let's sell it to be safe.

We Brits do it too.

How many funds sold off their shares in Stagecoach, the bus and train company, over fears that the City job cuts in 2008 would decimate the London bus network, without actually checking that Stagecoach had in fact sold off its London bus services ages ago?

Stagecoach duly plunged, only to stage a 60% comeback within 18 months.

Same company, same business, but a different share price.

Reality had got through at last.

But these little errors of judgement pale into insignificance beside the calamity that befell the Japanese car giant Toyota last year.

The world's largest motor manufacturer had been forced to recall 8 million cars, mostly over worries that their floormats might be jamming their accelerator pedals.

But the company now says that the recall cost only a bit more than a billion dollars, plus another billion or so in lost sales.

So how come the stock market wiped $30 billion off Toyota's share price during just ten days in February?

And how is it that, even after the start of the recovery, you can still buy Toyota shares at a 60% discount to what you'd have paid for them two years ago?

The scent of a trail

These sorts of price lunacies get my antennae twitching.

Yes, it's very possible that Toyota might have further safety problems in the future.

It might be that Americans, who buy a third of all Toyotas, will be reluctant ever to trust the company again. But somehow I doubt it.

Large companies like Toyota have a way of weathering these storms – and Toyota is bigger than most.

The company has just announced a $2 billion profit for the year to March, instead of the $7 billion loss that it had been forecasting/ I'd say that it won't be long before sweet mathematical reason returns.

Beating the herd instinct

Finally, let's return to our original question. Is there any way we can capitalise on the more blatantly irrational swings when they happen?

Well, the tricky part is that you've got to be sure they're really irrational in the first place.

There are plenty of genuine reasons why company share prices can nose-dive (and entire markets too), and it would be a shame to pin your money on a bunch of deserving losers.

But I'd say you can narrow down the field by seeking out those stricken companies that have been savaged particularly badly, and then (crucially) making sure that you understand exactly what they've done wrong, and exactly what their errors will cost them.

If they're large companies, so much the better because they'll have more recovery options than small ones.

If they've got cash in the bank, and if they're still paying good dividends (and likely to keep on paying them), then you've got quite a lot of the things that Warren Buffett, the world's wealthiest investor, goes out looking for when he makes his (infrequent) purchases.

He takes his time and he makes his moves. Then he just sits back and waits for bounteous normality to return. Easy.

As Rudyard Kipling might have put it, had his middle name been Warren:

If you can keep your head when all about you are losing theirs you'll be a billionaire, my son…


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