Clem Chambers: Getting used to roughride ahead is the key to a solid portfolio

FOR the last couple of years, an age-old market cycle has been getting more and more pronounced.

The notion of selling in May and going away (and not coming back until St Leger day, as the old adage goes) used to be about the effects of the city upper classes taking the summer off. This drop in activity created a slump, so an investor who sold in May and bought back in mid-September would protect themselves from risk and loss over the quiet months. Buying back after St Leger day would mean they would be investing during the bullish winter season.

This cycle still seems to be in place even though in a globalised market it seems that the holiday habits of Europe couldn’t possibly be creating this effect. However, now the cycle has grown, turning into a season sequence of crashes in the summer which has increased market fear in a self-reinforcing cycle.

Therefore it is a no-brainer to predict a summer slump this and every year. However, the only thing to expect from the market is the unexpected.

We are currently in a bear phase because the market is pre-empting this slump. Don’t wait until May, goes the thinking; get out in April. Pre-emption is how markets become efficient and cycles get broken. Before you know it, people are selling in March to pre-empt April.

This is why timing the market is so tricky.

So where are we now?

Traditionally, autumn will be very strong, as this is the cycle before the re-election of an incumbent US president. If you think Republican candidate Mitt Romney doesn’t have a chance, the autumn is very likely to be strong market period. A strong autumn in a sense gives the summer plenty of opportunity for weakness, so again it looks a good bet that the summer will be bumpy.

But what causes these summer slumps?

In short, I believe the root causes are the same as the root causes of the current crisis: massive trade imbalances between the developing and developed worlds. These trade imbalances mean that vast piles of capital end up in the developing world. In the modern global economy “mercantilists” can’t put their golden gain in a vault, they have to hedge their winning in world markets.

If you have won billions of dollars in trade you have to hedge the risk the dollar will plummet by buying and selling all sorts of global hedges.

Hedging hundreds of billions of dollars in currency and associated bonds across global markets is a big endeavour, and sudden changes or realignments of priorities create the kind of chronic market disruption that saps the vitality of the market and drags it down. This is what is going on these last summers. The creditor countries like China are rebalancing their vast reserves.

We saw the effect of hedging gone bad in the flash crash, when one huge trading robot malfunction precipitated a market rout. The knock-on effect of that volatility was to put severe strain on the market as the perception of enhanced risk turned into a negative overall market reaction that dragged on the market for months after.

The hedging of global trade imbalance in the summer is my explanation for the summer slumps we have become used to.

As such, we will be lucky indeed to avoid a nasty correction between now and September, yet in the end – unless you feel like trading – its probably best to sit tight and tough it out this year.

The “great recession” is coming to a close even as a new era of economics opens up, and it will remain difficult to time the market to make money from the short term. Equities are a solid haven for the long term and getting used to the rough ride ahead is probably the key to building a solid portfolio as the new economic order takes shape.

• Clem Chambers is chief executive of stocks and shares website ADVFN.com