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Delphian Blog

State Modeling™ Helps Predict When to Sell Stocks

Posted by Michael McNelis on May 15, 2016 4:45:30 PM

Sell in May and go away?

There is an axiom in the market that suggest you should sell stocks in May and not get back into the market until November.

Many markets, especially commodity based markets have seasonality trends. For example, in the summertime we see an increase in oil prices due to the summer driving season. Often, we will see the stock price of oil companies’ rise during this period.

History suggest that this is more than a folksy axiom. Surprisingly, from 1950 through 2015, the average monthly returns for the S&P 500 from the November through April periods are dramatically higher than the May through October periods. Returns from November through April are 1.42% compared to 0.52%.

This year may have even more reasons to sell in May. One, we have a presidential election. Wall Street does not like uncertainty. The polls are tightening and quite frankly America doesn’t seem to be enthused by either candidate. This uncertainty leads to selling. The last three presidential races resulted in a loss in the stock market from May through October. In 2008 the loss was 27.3% in the Dow Jones Industrial Average.

This year could be worse. The one fundamental indicator I look at is the Price/Earnings Ratio. The price-to-earnings ratio (P/E) is a valuation method used to compare a company’s current share price to its per-share earnings. It can also be used on Indexes.  Dividing the common stock market share price (numerator) by earnings per share (denominator) produces the ratio. For example, let us do a sample calculation with company XYZ that currently trades at $100.00 and has an earnings per share (EPS) of $5.00. Using the previously mentioned formula, you can calculate that XYZ’s price-to-earnings ratio is 100 / 5 = 20.

Historically, The S&P 500 has averaged a P/E ratio of 16.67. Currently it is 25.68. With current earnings of $87.53 for the S&P 500, if you used its average P/E of 16.67, the Value of the S&P should be 1459. Currently The S&P 500 is trading at 2055. This would be a 29% movement to the downside if it reverts back to its historical average. Prior to the collapse in 2008, the P/E ratio was at 28.

Finally as of this writing, Our Major Indexes have just entered into a mildly bearish State 2 in the Key2Options Program for the first time in about 60 days. Our State Modeling predicts when stocks will go up (bullish) or when they will go down (bearish).

Characteristics of State Modeling

State 1 Bullish Extremely Bullish Price rise upwards
State 2 Bearish Pullback from uptrend Pullback from uptrend
State 3 Bullish Bullish Bulls and Bears are fighting aggressively but still mildly bullish
State 4 Bearish Moderate Bearish Lead indicator for upcoming sharp downtrend
State 5 Bullish Moderate Bullish Bulls and Bears are fighting aggressively but still mildly bullish
State 6 Bearish Bearish Expect new lows and sharp falls
State 7 Bullish Pullback from downtrend Pullback from downtrend
State 8 Bearish Extremely Bearish Price fall downward and expect new lows

States 1, 3, 5 and 7 are bullish States. States 2, 4, 6 and 8 are bearish States. State 1 and 8 are at the extremes of bullishness and bearishness.

This could be the sign of a small pullback or a prelude to a dramatic sell off in the coming months. Check with the Key2Options blog post at http://key2options.com/blog/ to stay up to date with the latest trends in the financial markets.

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