The shaking is just a tremor — so far. The major U.S. stock indexes have finished down for three days in a row. The Dow Jones Industrial Average DJIA, -0.93% tumbled more than 200 points, or 0.9%, on Thursday, falling below the 22,000 barrier it had only recently broken. The broader S&P 500 SPX, -1.45% lost 1.5% on Thursday while the Nasdaq COMP, -2.13% slid 2.1%.
In the context of a market that’s been rocketing this year, this doesn’t look like much. In the context of an international crisis involving nuclear weapons, it seems astonishingly slight.
Could the market be about to slide further? There’s one good reason to think it might.
Looks like Wall Street’s annual summer sale may be here. Contrary to what a rational person might expect, the old stock market adage “Sell in May and go away” has some weight to it. Substantial academic research has found that the summer months tend to be pretty meager for investors. Returns between May 1 and October 31 tend to be lower than those in the winter months — and this has held true for decades in almost every market in the world.
Those overall returns mask a lot of variation along the way. A while back I sat down and ran an analysis of the S&P 500 and how it had performed in each summer since 1950.
Bottom line? There is usually a summer selloff. In 63 out of 66 summers, the S&P 500 at one point closed below the level it had set on May 1. In half of those selloffs the decline was trivial — a few percent or so. You might therefore argue that we saw the summer selloff in May, when the market dipped.
However, in 53% of summers the market fell by at least 5% from its May 1 level, and in 26% of them it fell by 10% or more. Full-scale summer routs, where the market plunged by 15% or more, are not uncommon — occurring in one summer in five.
There may be solid reasons for weakness in the summer period, typically measured from May to September or October. People go on vacation, and most people are bulls. There are therefore fewer ready buyers around to pounce on any weakness.
The past may be prologue or irrelevant, which is what makes stock markets so interesting. But almost every other piece of market analysis and financial advice is based on extrapolation from the past, so I’m in good company.
Based at least on history, there’s a 50% chance of a decent selloff and a one in four- or five chance of something really hefty. Remember, too, that these past declines were measured from the May 1 level. We’re already a couple of percentage points above that.
So with history as a guide, we have a 50% chance of seeing the Dow fall just below 20,000 (a 5% decline from May 1 would take it down to 19,868), a 25% chance it will fall just below 19,000 (18,822) and about a 20% chance of tumbling to 17,776.
It’s worth noting that none of these falls, while startling, would leave stocks looking cheap by long-term measures. That’s the lesson of history. But of course if it were easy, we’d all be rich.