Weekly Market Outlook

Goldman Says Investors Should Sell In May This Year

“Sell in May and go away” goes the old investment adage.

Analysts at Goldman Sachs Group Inc. agree—this year, at least.

While the team, led by Chief U.S. Equity Strategist David Kostin, is sticking with its end-of-year S&P 500 target of 2,100, the analysts reckon there could be some serious volatility along the way.

“A drawdown during the next few months could find the S&P 500 index falling by 5-10 percent to a level between 1,850 and 1,950,” they write in their latest research. Like Savita Subramanian, their counterpart at Bank of America Corp., who last week warned that an impending vortex of negative headlines could push the S&P 500 down to similar levels, the analysts identify a slew of negative trends that have the potential to hurt investor sentiment.

Here are a few of them.

High valuations

Price to earnings ratios—a popular measure for whether a stock is expensive relative to history and to its peers—remain stubbornly high. To illustrate this “extended valuation,” Kostin and his team point out that the forward P/E multiple of the S&P 500 is now in the 86th percentile, when looking back over the past 40 years. The median stock in the index trades in the 99th percentile of historical valuations, the bank adds.

Supply and demand

Investors weren’t very quick to buy U.S. stocks during the first few volatile months of 2016. “Even as the S&P 500 index rebounded from its Feb. 11 low, institutional and hedge fund U.S. equity futures positions remained net short,” Goldman writes. That has changed quite drastically. “Sentiment has shifted sharply during the past few weeks. Since the end of March, investors have bought $23 billion worth of futures positions, lifting our Sentiment Indicator to 32, a less bullish level compared with mid-winter.”

No one knows what the Fed will do

There isn’t much consensus as to when the Federal Reserve will raise benchmark U.S. interest rates again. While Goldman economists expect two hikes this year, the wider market is pricing in even chances of one or fewer rate increases. The mismatch means “more likelihood exists for an incremental hawkish surprise than a dovish surprise,” the equity analysts write.

It’s an election year

An unconventional political season means that Goldman’s clients are paying even more attention to electoral campaigns. “The U.S. presidential election is now part of every client conversation,” Kostin and team note. Even without the added surprises, the S&P doesn’t usually do well during the summer of election years. “History shows that during a typical presidential election year, the S&P 500 index remains relatively range-bound until November,” Goldman says.

So what’s a vacation-averse investor to do?

Kostin & Co. suggest using options to capitalize on the low probability that markets are currently placing on a sell-off. “Unbalanced distribution of upside/downside risks suggests ‘sell in May’ or buy protection,” the analysts conclude. “We recommend selling upside calls to fund downside protection given options market prices a below-average probability of a drawdown in next three months.”