Sell in May and Go Away
As May approaches there will be more and more discussion of this Wall Street adage. Based on a British maxim (Sell in May and go away, and come back on St. Leger’s Day), this referred to the seasonal custom of wealthy Londoner’s leaving the heat of the city and going to the country and returning for the St. Leger’s Stakes, the third leg of the British Triple Crown in mid-September. Ironically, when applied to the stock market, the results show the historical seasonality of returns. Going back over a 65 year period from 1950 through 2015 the May-October period for the S&P 500 averages a loss of 1.7% with only 36 years positive, while the November-April period has returned 9.2% with 57 years of gains. What is more astonishing are the 65 year gains (loss) on an initial $10,000; the May-October investment returned a -$6,709 and the November-April period showed a gain of $2,496,640.00. Why then do managers not follow this phenomenon? Selling and buying stock is not a part-time business. Although there are data to show that the markets over time follow a pattern, seasonality is not reason enough to sell stock. The determinants of stock market valuation do not include seasonality no matter how many people head for the beach. For Example, seasonality is questionable in October, which has four of five worst days in the S&P 500 since 1950, has three of the best five days.
Stocks, as measured by the S&P 500 Index, remain in a tight trading range which began after new highs on March 3rd. As of last Friday, the Index was only 2.1% off its highs. Examining the performance of the major S&P 500 sectors shows that Technology is clearly outperforming all other sectors, while relative performance favored Industrials and Consumer Discretionary. The shift back to more economic sensitive sectors is significant as many managers have cited weakness in the economy for 1Q2016 to continue into 2Q2016. Real GDP growth will be released this coming Friday and is forecast to be below 2.0%, with the Atlanta Fed’s GDPNow at 0.6% and most others in the 1.0%-1.5% range. Whatever the number for 1Q it appears the economy is locked in at 2.0% for 2017, unless a retroactive tax cut passes before year-end. Earnings, though still early in the reporting season, are coming in above expectations. But it is too early to know how much optimism is already reflected in stock prices. As we have said since the election, the Trump Agenda, if followed, would stimulate economic growth. To date, nothing has changed except limited progress in the form of reduced regulation with no movement in fiscal policy. Thus far, the swamp remains full.
A Perfect Storm
Politics – Other than a Supreme Court appointment, the Congress, including both sides of the aisle, seem hell-bent on screwing things up. Democrats are expected to vote against anything coming from the new Administration, but it is the Republican side that fails to realize the closing window of opportunity. GOP Congressmen, sensing risk being tied to an unpopular president may undercut any controversial legislation as the midterm elections approach. These are the same inept Republicans who voted eight times to repeal Obamacare and 40 additional times to get the Law changed, but not actually repeal it. After all of this legislative BS, the GOP House members had no plan to replace the Law. With only significance for a small universe of related healthcare stocks, the repeal of Obamacare is threatening the implementation of fiscal policy, which has been absent since the financial crisis. Talk about a full swamp, this is quicksand.
The latest version of the Healthcare Bill reverses all the tax increases and cuts Medicaid substantially by setting up a separate fund for high-risk individuals. Responsibility for the Fund would shift over to the States, thereby lowering the Federal Government costs which would offset the revenue shortfall for tax cuts. Today, Speaker Ryan let it be known that there is no rush to vote on Healthcare. This flies in the face of the President’s intention of passage within the artificially-hyped 100-day window. Also today, a new NBC/WSJ poll shows 45% of respondents believe Trump is off to a poor start. This accompanies a 40% approval rating, the lowest of any President in 50 years. These low levels indicate growing frustration in the domestic agenda. The snail’s pace of Congress is anticipated, but the new Administration shares the blame. To date, 85% of key executive governmental appointments are unfilled. Of 554 requiring confirmation, 473 have no nominee and only 24 have been nominated, of which 22 confirmed. The majority of these positions are still held by Obama appointees. This is particularly troubling as Congress interacts with these appointees and also of concern is the sentiment of the Trump White House that there is no rush as they can ably do it alone.
To avoid the missteps of Healthcare, the process for the Tax Bill will be more deliberate, allowing hearings and bipartisan overtures. Democratic support is unlikely as agreement over tax cuts for the middle class relative to favoring the wealthy will short circuit any bilateral agreement between the party’s leaderships. The recent Supreme Court nomination showed that the possibility of any meaningful crossover of the vulnerable ten Democratic senators is highly unlikely. It will be a long slog with growing frustrations even if the repeal of Obamacare comes quickly. For now, attention will be on the budget and the possibility of a government shutdown. This should prove a short-term distraction and not an interruption with little or no effect on stock prices.
The Economy – For the next couple of weeks after the release of the GDP data, the 2% economy will be characterized with low growth by persistent media comments of a slowdown continuing into the secondhalf of the year. Permabears, uninformed bears, and the financial media will join together to herald the upcoming recession and the end of the nine-year bull market. Not so, the economy is growing, interest rates and inflation remain low. The global economy is improving, the IMF just raised its growth estimates across the board, and the China transition is succeeding as recent growth at 6.9% was above the estimate of 6.5%. Oil has stabilized and trades in a $45-$55 a barrel range and French elections, scheduled for June, will have less impact on the US than Brexit.
Growth, not contraction, in 2Q2017 as consumer spending, housing, and Capex improve. Consumers, despite a slowdown in auto purchases, will be buoyed by a strong balance sheet evidenced by an historically low debt ratio. Housing is backloaded with low inventory and home prices and rents are rising. New Housing Starts were down in February from January, but rose 9.2% over last year and can be expected to rise in 2017 as millennials settle down. We expect Single Family Starts to accelerate as the year progresses.
There is much discussion on Retail Sales data from the Commerce Department, particularly the negative month-to-month declines in February and March 2017. Almost all of the lower sales are in clothing stores and department stores. Consumers have not stopped buying clothes, but have shifted away from instore purchases. Credit Suisse estimates that over 7,000 brick-and-mortar stores closed in 2015 and 2016 combined. For 2017, their estimate is 8,600 closings. Whether voluntary or involuntary buyers will gravitate to online purchases. Gasoline station sales are dictated by oil prices. Buying the same amount of gasoline at a lower price is a negative for retail sales but an increase in consumer purchasing power. On a year-over-year basis, Total Retail Sales rose 4% for 1Q2017. Business fixed investment, an important step to increased productivity, is showing signs of improvement. Elimination of non
productive regulations, particularly for small companies, has aided technological upgrades. For larger companies, expanding Capex needs tax certainty.
Our investment policy remains optimistic. We do not discount the possibility of a market sell off as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity. It is unlikely given the growing strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted. Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies. To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.