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Marcuard's Market update by GaveKal Dragonomics
The time-honoured adage of “Sell in May and go away” has served equity investors extremely well for the past four years. In every year since 2010, stock markets have corrected sharply, falling from a high in May to a low in the summer or early autumn: in terms of the S&P 500 by 15% in 2010, 19% in 2011, 9% in 2012 and 5% in 2013. Given that the S&P closed last week less than 1% shy of its all time high and that the Dow Jones Industrial Average has just hit a new record, it may seem sensible to respect the seasonal pattern regardless of your views about the longer term outlook. An additional reason for caution emerged last Friday with Wall Street’s churlish response to what were by almost any standards extremely bullish US employment figures.
Not only did the monthly payroll gain of 288,000 comfortably exceed the consensus but the revisions to the three earlier figures suggested strongly that the slump in the US economy at the turn of the year, which caused a brief market panic in January, really was a weather-related aberration whose impact diminished steadily through the winter. That, in turn, made it very likely that the dismal first quarter GDP figures would be revised upwards and that growth in the second quarter would accelerate to above 3%. Better still, the good news on growth—which will almost certainly translate into stronger corporate revenues and profits in the second quarter—was neatly counterbalanced in the payroll report by some softer figures on wages and labor force participation, which ticked down from 63.2% to 62.8%, more or less guaranteeing that the Fed would remain dovish despite the sharp fall in the unemployment rate to 6.3%, the lowest rate since before the Lehman bankruptcy.
Yet despite all this good news, Wall Street closed marginally down on Friday after the S&P 500 tried—and failed again—to break last month’s high. More alarmingly, bond yields fell sharply, with the 10-year Treasury breaking decisively below this year’s trading range and the 30-year plunging to its lowest level since last June. This bond market action put fixed income way ahead of equities in terms of year-to-date performance and strongly implied that investors can “smell a rat” in the bullish news from the US. Where might this rat be hiding? For once, it is difficult to blame Europe. The PMIs from all over Europe announced on Friday, showed major improvements, with even Italy, Spain and Greece climbing well above 50 for the first time since 2011. Most emerging markets have also been performing strongly and early figures on Japanese store sales suggested that last month’s tax hike may have done somewhat less damage than expected.
What, then, might explain Wall Street’s inability to rally on good news and the plunge in bond yields last week? There are two obvious explanations: geopolitical risk from the escalating violence in Ukraine and excessively bullish investor positioning at a time of seasonal pressure for a sell-off in May. Assuming for the moment that the situation in Ukraine does not deteriorate much further (admittedly a big assumption), is the seasonal factor really something to fear? Probably not. Looking back at the “sell in May” corrections since 2010, all four have been triggered by sudden scares about a US growth slowdown. Once these growth scares dissipated, the corrections reversed sharply. This year, however, the US growth scare has already happened and leading indicators all suggest accelerating activity and stronger corporate figures, at least over the next few months. Moreover, equity market gains in the first four months of this year have been smaller than in any year since 2009, while bond markets have done better than in any of the corresponding periods since 2003.
It seems therefore, that this is could be the ideal time to follow Charles’s recommendation to maintain balanced portfolios of equities and long-term Treasuries—and to rebalance at least once a quarter, especially when one asset has significantly outperformed. Right now, that rebalancing would mean that equity investors should reverse the time-tested adage. For the first time since 2009 this may be a year to buy in May.
