‘Don’t Sell a Dull Market Short’: S&P 500 Defies Summer Slump

Key Takeaway

• Historical data since 1972 shows no significant correlation between summer trading volume and S&P 500 performance, debunking "Sell in May" theory.
• Diversified portfolios have underperformed the S&P 500 for 13 of the last 15 years, driven by tech megacaps and high Treasury yields.
• Market breadth has contracted despite S&P 500 highs, with small caps underperforming; this could signal short-term risks but may support long-term bull trends.

Summer Trading Volume

As summer approaches, many investors are preparing for vacations, leading to a decline in stock-market trading volume during June, July, and August. This seasonal trend has led to concerns that the market might struggle, based on the theory that price follows volume. The adage "Sell in May and Go Away" is often cited in this context. However, a detailed analysis of historical data since 1972 reveals no significant correlation between trading volume and market performance.

The analysis involved calculating the ratio of NYSE average trading volume to its trailing 12-month average for each month. The correlation between this ratio and the S&P 500's total return in the same month was found to be statistically insignificant. Further tests to determine if volume could be a leading indicator for future market performance over 1-, 3-, 6-, and 12-month periods also yielded no significant results.

Some market technicians argue that the interaction between volume and price is more crucial than volume alone. However, even when focusing on months where both trading volume and the S&P 500 were lower than the previous month, the market's performance did not differ significantly from other months. This suggests that other indicators might be more reliable for forecasting market direction.

Diversification Challenges

Investors who have adhered to the traditional strategy of diversification are facing a challenging period. Despite spreading investments across bonds, equities, and other assets, diversified portfolios have underperformed compared to those focused solely on the S&P 500. According to Morningstar Inc., only one out of approximately 370 asset-allocation funds has managed to outperform the S&P 500 since 2009.

While diversified portfolios have still returned around 6% annually, they have trailed the US large-cap stock index in 13 of the last 15 years. This underperformance is partly due to the strong performance of US stocks, driven by technology megacaps like Nvidia Corp. and elevated Treasury yields. Meb Faber, founder of Cambria, describes this period as a "bear market in diversification."

The psychological toll of underperformance is significant for both small investors and large money managers. Institutions such as pensions, endowments, and foundations have $21 trillion invested in diversified strategies. Despite the risks associated with concentrating investments in US stocks, the consistent outperformance of these stocks has led to doubts about the benefits of diversification.

Market Breadth Concerns

Market breadth, a measure of the number of stocks participating in a market move, has contracted recently despite the S&P 500 trading near all-time highs. This contraction is evident in metrics like the NYSE cumulative advance-decline line, which has pulled back since mid-May. Short-term momentum for the advance-decline line is currently to the downside, indicating a potential short-term risk for major indices.

The ratio of the small-cap Russell 2000 Index to the S&P 500 has also broken down to a new 52-week low, continuing a primary downtrend. This suggests that small caps are underperforming relative to large caps. Despite these signs of deteriorating market breadth, a previous breakout in the NYSE advance-decline line suggests that breadth could eventually expand in support of the cyclical bull trend in the S&P 500.

Katie Stockton of Fairlead Strategies notes that periods of breadth contraction during uptrends can be healthy, as they can renew demand when markets appear extended. However, the current negative divergence between price and breadth metrics makes the market more sensitive to potential 'sell' signals.