The mayhem in equity markets in May could extend to June
May was a troublesome month for equity markets. It was the worst May for U.S. equity markets since 1940. The loss by the Dow Jones Industrial Average reached 7.92 percent leaving many investors uncertain about the global economic recovery.
What happened in May 1940? The Dow Jones Industrial Average fell 21.7 percent that month. In June, it recovered 5.0 percent, recording one of the biggest gains in June since the dirty thirties. However, compared with the loss experienced in May, the June rebound was a mere drop in the bucket.
Equity market losses this May were comparable to losses recorded in 1962 when a decline of 7.81 percent was recorded. The drop in May 1962 was followed by an additional decline in June of 8.49 percent. Coincidentally, 1962 was a mid-term election year, similar to the present timeframe. Is history about to repeat?
Performance by equity markets prior to the May 1962 correction looks eerily similar to market conditions in 2009. Equity markets moved higher in 1961. The gain by the Dow Jones Industrial Average topped 18 percent before stabilizing in the first quarter of 1962. And then, the bottom fell out. The Dow Jones Industrial Average fell 30% from March to the end of June. Equity markets finally regained a firm footing in October and a Fall rally ensued.
The May-to-September period has not been favourable for equity markets in midterm election years. Uncertainty about future control over the U.S. Congress and possible changes in policy following mid-term elections creates uncertainty in the economy, which, in turn triggers uncertainties in equity markets.
History shows that a decline by the Dow Jones Industrial Average by greater than 5 percent in May has not been followed by a significant recovery since 1940. June recoveries averaged only 0.91 percent with the bulk of gains occurring outside of midterm election years. Generally, losses in May during midterm election years lead to further losses in June.
A seasonal chart on the performance of the Dow Jones Industrial Average for midterm election years during the past 81 years shows uncanny similarities to the current timeframe. A February-to-April rally turns into a Spring- through-Summer downfall followed by stability and a recovery in October.
Is the loss by the Dow Jones Industrial Average beyond its 7.92 percent decline in May expected to continue? Probability is high. The short-term rebound witnessed this past week during the Memorial Day holiday period is common during mid-term election years. A close look at the seasonal chart for mid term election years shows a similar short-term rebound during the last week of May and the first week in June, precisely until release of the crucial May jobs report. Beyond that point, declines are the norm and they usually last until the end of the month.
Bottom line is that past history does not reveal a favourable June in midterm election years. Prepare yourself for a rocky road ahead.
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