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Stocks In For Another Summer Stumble?

Are U.S. stocks setting up for another summer slump?

If so, they’ve started early. The S&P 500 lost 2.7% over the past two weeks, its worst showing since November.

A longstanding mantra on Wall Street holds that investors should “sell in May and go away.” Since 1950, four of the 12 calendar months have averaged negative yearly returns. Three of these come during summer: June, August and September. (The fourth is February, not October, despite  the occurrence of some historic crashes during the latter.)

That’s an example of a correlation that lacks a clear cause. There are theories on why stocks have underperformed in summer–”traders take vacations”, for example–but they’re not especially convincing in an era of automated, always-on trading.

The most likely explanation for the past success of selling in May is coincidence. But the saying sure seems convincing following last year’s sharp market declines during every month from May through September, and 2010’s even sharper losses in May, June and August.

Maybe the sell-off of the past two weeks was caused by investors not wanting to be late to the sell-in-May party this year. But there are some other, more likely explanations.

Stocks have soared but earnings growth is slowing. The S&P 500 doubled in just over three years, something that historically takes more than seven years. Corporate earnings estimates have fallen steadily since autumn, to the point where earnings for the S&P 500 are expected to rise just 5% year-over-year during the first quarter reporting season. That compares with 16% growth a year ago.

Jobs numbers in the U.S. disappointed earlier this month. Growth is slowing (but not slow) in China. Bond yields are rising in Italy and Spain, suggesting investors worry that both, like Greece, will have difficulty paying what they owe.

These aren’t new problems, but they suggest there’s no reason to pay a big premium for U.S. stocks. The S&P 500 closed Friday at 13 times this year’s operating earnings forecast. That’s close to its historical average.

There’s no reason to believe the recent sell-off is the start of a long summer plunge. But it looks every bit like the start of a period of slower returns for stock investors.


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