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Historical highs across a swath of stock market averages coupled with valuations that are priced to or near perfection do little to inspire confidence among investors already prone to worries about the month of May. Throw in Mad Dog Putin and his ongoing putsch, a world that remains closer to brinks of unrest than peace, and a housing market that could be showing more than a temporary soft patch, and the adage of selling in May and staying away seems like the best order of the day. That is, unless you focus on May flowers.
Longstanding readers of my column here, together with members of ETF Trader and Fidelity Sector investor, know that one proprietary metric I often turn to (and have model portfolios based upon) is a seasonality indicator that lets me view how past months over a span of a number of years have tended to fare relative to sector winners and losers. By looking at an average of the past five Mays, for example, I can see that some sectors tended to show green shoots, while others dug deeper and deeper holes.
I run the same metric for major market indexes in order to view the landscape of, for example, large-cap and international stocks, small-cap and emerging-market stocks, U.S. investment grade, corporate and junk bonds as well as cash, currencies and emerging-market debt.
This month, by combing the two charts, I can see which sectors have not only tended to deliver May gains but which sectors have tended to deliver better gains than the S&P 500 (.SPX) and the Barclays Aggregate bond index.
First, a look at the broader market indexes shows that May isn't the cruel month many investors simply assume it is. Gains are the rule, not the exception – but they're sprouting like gains in the main.
The second thing to note is that small caps, small-cap growth in particular, have had the best run of the bunch, and not just in May. From a valuation perspective, small-cap value stocks look to be the most overvalued currently — battleship balance blue-chip mega caps are, by valuation, the bargain.
This means I wouldn't want to run and buy the whole small-cap market or even its value and growth twins. If there are some overlooked and undervalued small-cap stocks, a superior active manager will prove her or his salt by finding them.
A more macro trend to note is that May has been generally OK. A five-year bull market in general helps. A lagging market in Europe helps explains the May wilt there. Altogether, I think May is setting up to sow an OK month for the major markets, but that it will be through sectors where the most flowers bloom.
My seasonal sector map suggests that planting staples, defensive growth and dividend payers has made the most sense. When bunched together, consumer staples, natural gas, financials, health care, telecommunications and a blended bond basket still make sense to me. I would even throw in a currently contrarian play: Construction and housing.
Here's why: Consumers are strong and confident and rational. But it will take more hard evidence to create more buying of stocks, it still seems about as easy as one headline rumor concerning world peace or global inflation to temporarily upset the apple cart. Selling on fear is still a buying opportunity in my book — but I'm not so arrogant or ignorant as to assume that that book doesn't come with some selling chapters in it. I just don't see a sustained catalyst for selling and selling and selling some more … not in May, not this year ... at least not yet.
I like pairs of consumer staples: an actively managed index ETF like the Powershares Consumers Staples (PBJ), whose top holdings are Pilgrims Pride (PPC), Diamond Foods (DMND), Whole Foods (WFM), Hershey (HSY) and Cisco (CSCO), or the commission-free Fidelity MSCI Consumer Staples (FSTA), which is a more traditional basket reflected by its top holdings: P&G (PG), Coca-Cola (KO), Phillip Morris (PM), Pepsi (PEP) and Wal-Mart (WMT).
I'd combine one of those with the actively managed no-load Fidelity Select Consumer Staples (FDFAX): British Tobacco (BTI), Coca-Cola, P&G, CVS (CVS) and Kroger (KR). You're netting necessary goods while getting reasonable yield and return potential.
I like consumer staples paired with construction and housing: Fidelity Select Construction & Housing (FSHOX). I think weather-related impingements and fears of a slowdown make this sector riper for the picking more now than it was in the winter or will be in the fall. But having a manager who is nimble, quick, informed and able to out-execute will make a difference … and is Fidelity's Select fund core competency and strength. Top holdings here are Home Depot (HD), Lowes (LOW), Jacobs Engineering (JEC) and Vulcan (VMC). It's very interesting in that homebuilders aren't in his top 5, Lennar (LEN) is his eighth largest pick.
If things look up from here, consumers may get bolder about spending on the biggest discretionary item their money can buy — a new home, or an addition to their existing one. (I like health care. I've written about it enough to point you to past columns. It remains a market overweight in my newsletter model and real world investment portfolios.)
The next pairing I like best for May: more interest-rate-sensitive and mainly defensive telecommunications and total-bond blends. Again, I prefer active management in both spaces — this is both a stock and a bond picker's market. But while my charts suggest a telecom play, and while Fidelity has a reasonably good sector fund in the space — Fidelity Select Telecommunications (FSTCX) — I'd opt for the more defensive, higher yielding no-load Fidelity Select Utilities & Telecom (FIUIX), which enfolds telecom into the natural-gas play that the chart notes and captures some of the interest rate related market behavior that financials tend to trade on.
If health care remains the rose with a few biotech thorns, these four cornerstones mark May's investment garden for me. But bring a pair of boots — it could get very muddy.