The market just enjoyed its best first quarter since 1998, but if the last two years are any guide, investors might have one more month of solid gains before the old adage “sell in May and go away” takes effect.
The S&P 500 finished the first three months of the year up 13% on a price basis. The blue-chip Dow Jones Industrial Average gained almost 9%. The tech-heavy Nasdaq, meanwhile, hit levels last seen more than a decade ago, popping 20% in the first quarter to reclaim the 3,000 level for the first time since the dot-com era.
Equities’ outstanding performance came courtesy of investors embracing the so-called risk-on trade in force. Riskier assets like stocks soared, while defensive plays — notably Treasurys — lagged markedly. Short-term Treasurys slipped 0.2%, while government debt maturing in seven to 10 years lost more than 2%. Treasurys coming due in at least 20 years dropped 7.5%.
The total bond market was also a loser in the first quarter, slipping a fraction of a percentage point, and other defensive stocks and assets lagged as well. Gold, for example, added just 7% in the first three months of the year — barely more than half what the S&P 500 logged.
After a torrid first quarter, bullish market strategists either have to lift their year-end forecasts — or figure that some sort of sell-off, or at least sideways trading, will come into play. Stocks, remember, never move in a straight line.
And those investment that were first could easily be last in the second quarter if the risk-on trade switches off again — as it has the last two springs, notes Jeffery Kleintop, chief market strategist at LPL Financial.
“In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April,” Kleintop writes in a recent report to clients. “On April 23, 2010 and April 29, 2011, the S&P 500 made peaks that were followed by 16% and 19% losses that were not recouped for more than five months.”
Kleintop still thinks the market will end the year with strong gains, but he cautions that it could take a twisted routed to get there. After all, the risk-on trade faces an obstacle course of hurdles, Kleintop notes, including: the end of the Fed’s Operation Twist stimulus program, rising oil prices, China’s economic slowdown, the European recession, uncertainty over the presidential election and anticipation of the 2013 federal budget bombshell of tax hikes and spending cuts.
If markets do stumble, Kleintop figures it could be more mild than in the previous two years, thanks to accommodative monetary policy among the world’s central banks, signs of life in the housing market, lower food prices and robust auto production schedules for spring and summer.
But after coming so far so fast, don’t be surprised if stocks suffer through a listless second quarter or even a sell-off, while bonds and gold regain momentum. Most important: Don’t forget that if you’re properly allocated across asset classes, you’ll be prepared for the risk-on trade or the risk-off, in either case.