Why investors need not sell and go away this time to avoid the May effect on stocks

MUMBAI: The 1607-point decline on the Sensex in the past two weeks has unnerved many investors, but there could be more pain in store. May has historically been a bad month for stocks -in the past 24 years, the average monthly return of the Sensex has been a niggardly 0.24%. This weakness is a global phenomenon, which has led to the coining of the popular stock market adage: “sell in May and go away.” Though it is called the May effect, the correction doesn’t strictly correspond to the calendar month. As is the case this year, the weakness sets in mostly in April. The correction can also come later, as it did in June 2013.

On some occasions, extraordinary events have proved the rule wrong. Last year, the euphoria over the BJP’s victory in the parliamentary elections saw the Sensex shooting up by more than 8% during May .

If we don’t consider the calendar month, the Sensex suffered an average decline of 3.94% due to the May effect in the five years since 2010. This year, it has already taken a 5.5% hit and analysts say the worst is yet to come.

Poor fourth-quarter results, tax worries of foreign investors and unseasonal rains have created a perfect storm that can accentuate the May effect this year.

“Though it is too early to comment on the overall results season, there are some disappointments,” says K Sandeep Nayak, executive director and chief executive of Centrum Broking. The disappointment is greater because the market was expecting good news.

“After a business-friendly and stable government came to power last year, there were hopes that things will start improving. Since the recovery is still not strong enough, it is affecting the sentiment,” says Jigar Shah, CEO of KIM ENG Securities. The other pain point for the market is the minimum alternative tax (MAT) notices sent to foreign portfolio investors (FPIs). Sources say the tax department has is sued MAT notices to around 100 FPIs.

Some of these are related to matters dating back 7-8 years. “This retrospective tax is causing a lot of anguish,” says Shah. Though it has been clarified that FPIs covered by double taxation avoidance agreement will be exempt from MAT, it does not solve the problems of FPIs coming from other countries. Experts feel this will put markets under pressure.

The weather has also cast gloom over the markets. As if the unseasonal rains that damped rural demand were not enough, the meteorological department has predicted a below-average monsoon.

Monsoon’s failure can lead to high food inflation and further hurt rural demand. Inflation had come under control due to a fall in global commodity prices, especially crude oil. The recent pullback in crude prices may push up inflation once again. This will force the central bank to delay rate cuts. Though things are not looking rosy in the short-term, analysts remain bullish in the mediumto long-term.

“Though the Nifty could dip below 8000 levels during this turmoil, it can’t be sustained there because value buyers will emerge. Our Nifty target for December remains at 9540,” says Shah. This means long-term investors should use this annual phenomenon as an opportunity to pick stocks at low prices.

In doing so, they will only be following another famous stock market saying: “Buy when there is blood in the street.”