Don’t sell in May and go away: Why stocks have room to run

Investors may be tempted to reduce exposure to equities right now. After all, major stock indices around the world, from the STOXX Europe 600 to the Dow Jones Industrial Average, have hit record highs in the last several weeks. And then there is the old adage “Sell in May and go away,” which suggests that investors should dump stocks during the summer and reinvest in the fall. I’m not a fan of seasonal investment strategies, and I don’t believe new market highs should necessarily be feared. Here are six reasons why I’m confident that stocks can move higher from here.

1. More signs suggest US disinflation is re-accelerating

In last week’s blog, I wrote that the most important data release last week would be the US Consumer Price Index (CPI) data for April. That’s because US disinflationary progress appeared to have stalled in the first quarter. The good news is that headline CPI was in line with expectations at 0.3% month-over-month and 3.4% year-over-year.¹ More importantly, core CPI was 0.3% month-over-month and 3.6% year-over-year.¹ The core CPI reading was the lowest since April 2021.¹

And while at first blush the US Producer Price Index (PPI) for April seemed hotter than expected, a closer look indicated a benign print. Further, US retail sales came in lower than expected.

Taken together, this recent data indicates the US economy has been cooling modestly and disinflationary progress has resumed. This should help increase the Federal Reserve’s confidence that it will be appropriate to begin cutting rates soon. And lower rates could push equities higher. Historically, in the 12 months following the start of the last seven Fed rate cut cycles, global stocks, as represented by the MSCI All Country World Index, have risen on average more than 6%.² And if we were to strip out the rate cut cycle that began in 2007 as the Global Financial Crisis was just beginning, the average return for the MSCI All Country World Index is more than 10%.²

2. Earnings season featured largely positive results

We needed to see a solid earnings season in the first quarter in order to provide a solid foundation for stocks to move higher. And by and large, we got that.

• For the first quarter of 2024, with 93% of S&P 500 companies reporting actual results, a whopping 78% of those companies have beaten earnings expectations and 60% of those companies have beaten revenue expectations.³
• Of the STOXX 600 companies that have reported first-quarter earnings to date, 60.7% beat estimates, versus the average quarterly 54% beat rate.⁴
• Small caps also experienced a positive earnings season. Of the 1,621 companies in the Russell 2000 that have reported earnings to date for the first quarter, 59.5% reported beating expectations.⁴

3. Stock buybacks are on the rise globally

As I’ve mentioned before, stock buybacks are on the rise in many parts of the world. For example, just a few weeks ago, Apple announced plans to buy back $110 billion in stock. And European and UK companies have significantly increased their stock buybacks, with their buyback yields now at levels seen in the United States. A 2021 Vanderbilt Owen Graduate School of Management study looked at 17 years of stock buyback activity and concluded that, beyond helping to increase share prices, stock buybacks also increased liquidity and lowered volatility.⁵

4. Valuations are attractive for many equities around the world

Yes, some US stocks sport high valuations — although most of the high valuation “Magnificent 7” type stocks are arguably supported by high expected earnings growth — but many equities around the world have low valuations relative to their historical ranges. For example, Chinese equities are very attractively valued — they are currently at the very low end of their long-term cyclically adjusted price-to-earnings ratio (CAPE) range. And Japanese, emerging markets, European, and UK equities are all at or below their 10-year average CAPE.⁶

While valuations are rarely predictive of outperformance in the short term, in general low valuation stocks have often realized upside potential with a catalyst or catalysts such as better-than-expected earnings or some form of policy support. In other words, low valuations and positive surprise can be a powerful combination. I believe it is likely that non-US stocks and smaller-cap stocks may perform better as rate cuts unfold and we near a global economic re-acceleration.

5. Cash is sitting on the sidelines

As I have said before, there is a significant overweighting to cash on the part of some investors, both retail and institutional. That excess cash sitting on the sidelines is likely to start moving to fixed income and equities once the start of rate cuts appears imminent. This could be a powerful catalyst for equities.

As a reminder, US money market assets peaked in the fourth quarter of 2008 before dropping significantly. It seems no coincidence that cash moved off the sidelines just as stocks began a strong and lengthy rally in March of 2009.⁷

6. Geopolitical tensions haven’t derailed stocks yet

It seems that geopolitical risks have multiplied in the past several years. However, investors seem to be reacting to geopolitical risks not by eschewing risk assets such as equities but by including perceived geopolitical risk hedges such as gold in their portfolios. The use of geopolitical risk hedges seems to have enabled investors to be comfortable maintaining exposure to equities. In fact, gold hit a new record high on May 20, likely helped by news of a Houthi attack on an oil tanker over the weekend as well as the death of the president of Iran in a helicopter crash, either of which could add to tensions in the Middle East. But that does not seem to be dragging down stocks.

Risks to watch

While positive on equities, I recognize that there are certainly risks to watch this year. I think we could certainly experience one or more stock market pullbacks this year as expectations around monetary policy can change very quickly. That’s OK and could be healthy as it may present entry points to add to equity exposure. I do suspect that we are close to the start of a sustainable broadening of stock market participation. I hope this serves as a reminder to revisit stock portfolio weightings to ensure adequate exposure to small-cap and non-US equities.

The week ahead

Looking ahead, we will be getting a lot of “Fed speak,” and I expect it to be rather hawkish as the Fed tries to keep a lid on easing financial conditions. We will be getting some other central bank speak as well, but I expect that to be more dovish as a rate cut from the European Central Bank in June seems to be a fait accompli — and there remains a good chance other central banks also begin to cut soon.

The most important data release, in my opinion, will be US Personal Consumption Expenditures Index at the end of May. This will help paint a picture for the Fed about disinflationary progress in the second quarter and could bring us meaningfully closer to the start of rate cuts. However, this week I will also be paying attention to inflation prints for the UK, Canada, and Japan as well as Purchasing Managers’ Index readings for the eurozone, UK, and US. After all, it’s all about the balancing act between lowering inflation without snuffing out economic growth. Rounding out the week will be several central bank decisions, the Federal Open Market Committee minutes, and of course my beloved Michigan Survey of Consumers, which is “must read” material on Friday.