Sell in May and Go Away?

After a strong run in the first four months of 2011, the stock market has begun to waver -- right on cue. As the adage goes, "sell in May and go away" until November. Although stocks gained on May 18 and May 19, Standard & Poor's 500-stock index has lost 1.5% so far this month.

Should you base your investment moves on a Wall Street saw? For guidance, we checked in with Jim Stack, president of InvesTech Research and editor of the newsletters InvesTech Research Market Analyst and InvesTech Portfolio Strategy.

From his perch on the shores of Whitefish Lake, Montana, far from the madness of Wall Street, Stack has built a reputation as a top prognosticator. Seemingly clairvoyant at times, Stack called the beginning of the bear market in 2007 and the bottom in March 2009. In years of extreme market stress, such as in 2008, 2002 and 1987, Stack has shown an ability to protect his clients from disaster. Over the past decade through April 30, InvesTech’s stock portfolio returned 9.5% annualized, compared with just 2.8% for the S&P 500.

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Here’s an edited transcript of a recent conversation with Stack.

Kiplinger’s: We’re two-plus years into the bull market. How much longer can it continue?

Stack: By historical standards, we might only be near the midpoint of this bull market. In the past 80 years there have been 15 bull markets, and the average lifespan was close to 3.8 years. This bull market is 2.2 years old.

We still have broad participation from all sectors. All major indexes hit new bull-market highs in April. In fact, the Russell 2000 index [of small-company stocks] and the Dow Jones transportation average hit new all-time highs. There’s no better confirmation of an ongoing bull market than to have all major indexes hit new highs at approximately the same time. The kind of developments that have historically warned of a possible bear market -- such as the number of stocks hitting new lows -- are notably absent from the market now. That’s in striking contrast to the situation in the summer of 2007, prior to the last bull-market peak.

The stock market does seem overdue for a correction, doesn’t it? With the size of the run-up we’ve had over the past eight months, it wouldn’t be unusual to see a correction as we enter what is seasonably a soft period for the market. The market’s strongest period tends to run from November through May, and the weaker period runs from June through October.

But we’ve also seen an important -- and positive -- break in commodity prices, particularly the most speculative commodity, silver. We needed to see that correction in commodity prices to sustain the bull market in stocks through 2012. Otherwise, the kind of inflationary pressures that were starting to seep into the economy would start bubbling through to consumer prices and possibly lead to the Federal Reserve hiking interest rates later this year.

What do you think of the validity of that old adage, “Sell in May and go away?” Since 1928, the S&P 500 has averaged a gain of 5% from November 1 through April 30, compared with a gain of less than 2% from May 1 through October 31. So in theory, investors should watch for this pattern and use it to their advantage.

But over the past 83 years the market has logged double-digit losses in the summer period only 13 times. And in all those instances we were in bear markets. So in reality the May-October period is not a high-risk period. The seasonable softness in the summer months is a reason not to be to too aggressive, but not a valid reason for running for cover.

What should investors do now? First, hold your current allocations or reduce your exposure to stocks. Don’t increase your allocation to stocks during this seasonally soft period -- if for no other reason than we’ve had some spectacular gains since last August.

Second, move from sectors that perform well in the early parts of a bull market to those that perform well in the mature phase or even the end of a bull market. So move out of consumer-discretionary stocks, such as retailers and restaurants, as well as out of financial stocks. Transfer into, or boost your exposure to, the health care sector, which is one of the best-performing groups in the late stages of a bull market. Plus, the valuations for health care stocks are more attractive than those in most other parts of the market. Also, look at the industrial sector, where businesses are expanding and hold a lot of cash. It’s also not too early to look at makers of consumer staples -- the products people buy regardless of the health of the economy. There are some great value stocks out there -- Pepsico (symbol PEP) is a perfect example.

What else? In health care, I like Medtronic (MDT), which makes medical devices, from pacemakers to defibrillators to insulin pumps. It’s selling at an attractive price and yields 2.1%.

United Technologies (UTX), which makes aircraft engines, elevators and helicopters, among other things, has had a sizable run-up, but it’s still selling at a moderate price and it yields 2.2%.

In terms of company sizes and investing styles, what do you like now? It’s a little late to jump into small companies, which tend to do well in the first half of a bull market. The Russell 2000 has been the strongest index since the bull began. Because we’re probably entering the second half of the bull market, it’s better to focus on undervalued stocks of large and midsize companies.

For more insight from Jim Stack, become a fan of Jennifer Schonberger and Kiplinger’s Personal Finance magazine on Facebook. We’ll provide our fans with a couple of bonus questions and answers from Stack about his read on today’s market and signs that may indicate when the bull market will end.

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