Monday, April 25, 2016

Sell in May And Buy Back Higher In November

Summary: The "summer months" start next week. The period from May through October is known as the "worst 6 months" of the year for stocks. True, the probability of a truly bad month is higher and the probability of a really great stretch of months is lower during the summer than in the winter. But, overall, the expected return over the next 6 months is positive: median returns in winter and summer since 1970 are nearly the same. You might very well sell in May and buy back higher in November.

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One of the axioms of Wall Street is 'sell in May and buy after Halloween'.  Mark Hulbert says that over the past 50 years, the Dow has an average return of 7.5% from November through April ("winter") versus an average loss of 0.1% from May through October ("summer").

So, is the summer period that awful?

Using SPX instead of the Dow, the data since 1970 still favors winter over summer: the average return is 6% in winter versus 2% in summer.

But this data is skewed by a few outliers; stocks fell 37% in the summer of 2008, by 20% in 1974 and 15% in 1987, to name a few.

Using median values, winter's return is 5% versus 4% in summer. That's a very small difference. The returns in summer are typically positive, meaning, you might very well sell in May and buy back higher in November.

Overall, 76% of winters since 1970 have been positive; fewer summers are positive (67%), but the difference is slight.

So why do investors fear the summer months?  There are two reasons.

First: since 1970, 64% of the worst months (in which stocks fell 5% or more) occurred during the summer.  A bad month is twice as likely during the summer as the winter. 

Moreover, really bad seasons with losses of more than 10% occur more often in the summer: 13% of summers experience a "correction" versus only 4% of winters.

Second: great returns overwhelming take place in winter. 37% of winters produce a return of 10% or more. In comparison, only 17% of summers have produced a great return. A good stretch in the market is more than twice as likely during the winter as the summer.

Sunday, April 24, 2016

Weekly Market Summary

Summary: SPY made a new all-time high this week. The short and long term trend is higher. Despite a gain of 16% over the past 10 weeks, the majority of evidence indicates that investors largely remain skeptical and defensive. That, together with strong breadth, implies that higher highs still lie ahead. Shorter term, SPY is back to where it failed, repeatedly, to go higher in the spring, summer and fall of 2015. In the best scenario, attaining and then holding significant gains will likely take time.

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Equities rose again this week. Worldwide, equities gained 1.5%. Europe gained 1.5% as did US small caps. SPY and the DJIA gained 0.6%.

Weakness was confined to large tech companies: NDX lost 1.5% but the equal-weight version of NDX (QQEW) was flat. In other words, a few large tech companies pulled the Nasdaq 100 lower.

Safe havens - treasuries and gold - were weak: treasuries lost 2.6% and gold was flat.

By most accounts, the uptrend from the February low continues to be strong. SPY has gained in 8 of the past 10 weeks. It has also gained in 7 of the past 9 days.

Since mid-February, SPY and NDX have both gained 16%. Leading the upside, however, has been emerging markets, which are up 25%.

Advances as strong as the current one are relatively rare. The S&P has made a "higher low" every week since mid-February. Since 1954 (62 years), this has happened only 13 other times. What happened next? In every case, the S&P had a higher weekly close within the next 2 months. At the end of 2 months, 85% of these cases closed higher.

Below the surface, breadth has been strong. The NYSE advance/decline line - the cumulative total of the daily difference between advancing issues and declining issues on the NYSE - reached a new all-time high on Friday. This means that participation in the rally continues to be widespread.

For those concerned about a bear market, this is significant. The advance/decline line has declined before the S&P has made its final high at every cyclical top in the past 50 years. This implies further highs still lie ahead. Read more on this from Dana Lyons here (enlarge any chart by clicking on it).

Tuesday, April 19, 2016

The New All-Time High in SPY That Was Considered Impossible

Summary: SPY made a new all-time high on Tuesday despite falling margin debt, the end of QE, negative household fund flows, flat profit growth and a host of other reasons. In other words, exactly as a rationale and objective investor should have expected.

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SPY closed at a new all-time high (ATH) on Tuesday. Recall that SPY pays a 2% dividend, so a new ATH in SPY is equivalent to a new ATH in the S&P 500 index on a total return basis. The Dow Jones Industrials index has also made a new ATH on a total return basis (enlarge any chart by clicking on it).

Is this the top?

That has been the opinion of many nearly every week for several months and, in some cases, for several years. True, SPY is now at prior resistance from 2015 and there is the potential for an evening star to be forming. But the evidence for this to be a long-term top is no more compelling now than it was last week or last month.

The more important point about Tuesday's new ATH is that it occurred despite a long list of reasons a new high has been considered unlikely, if not impossible.

First, Tuesday's ATH comes 19 months after the Fed ended it's quantitative easing program. The end of QE3 in October 2014 was widely believed to herald the start of a bear market. A post on why this was likely to be wrong from November 2014 is here. Instead of dropping to 1500 as expected by Zero Hedge (first chart), the S&P gained more than 8% over the next 9 months (second chart). Even at the February low, the S&P was nowhere near 1500.

Second, Tueday's ATH comes 13 months after margin debt peaked. That SPY fell into a bear market within 3-5 months after a drop in margin debt in 2000 and 2008 amounts to an analog with a sample size of just two (chart from Doug Short).

Third, Tuesday's ATH arrives with negative equity fund flows by households. Two months ago, this was a rationale for a new bear market: "households are selling, this is all just corporate buybacks." But household flows have been negative for most of the past 20 years, during which the S&P has risen 380%. Whatever relationship between this data series and equity returns was imagined to exist simply does not (data from Yardeni).

Fourth, Tuesday's ATH came during the heart of the corporate buyback blackout that lasts until companies have reported their earnings. That equities are rallying in the absence of significant buybacks makes clear that there is much more to equity appreciation than just buybacks (rising cash flow, for example; first chart from Jonathan Golub). A post on this from November 2015 is here.

Fifth, Tuesday's ATH comes in the context of the Atlanta Fed's "GDP Now" forecast falling from 2.7% to 0.4% during the past month. But this is not unusual: since 2011, the model's growth forecast has regularly oscillated between 0% and 4% growth while the economy has been chugging along at 2.5%(from Bloomberg).

Moreover, 1Q GDP growth is typically the weakest of the year, averaging just 0.2% in the past decade. A weak 1Q16 would be normal (from Jeroen Blokland).

Sixth, the new ATH is coming when earnings and revenue growth are especially weak. We'll have more to say about corporate financials in a future post. For now, recognize that the heart of the 1990s bull market took place while GAAP earnings were flat (first chart, from S&P). Outside of energy, S&P margins have similarly been flat over the past 3 years (green line, second chart, from Yardeni).

Seventh, only a few months ago, a credit crisis (and therefore a new equity bear market) was considered assured given the widening spreads in high yield. But those wider spreads existed due mostly to low energy prices; non-energy high-yield spreads were not alarming and overall defaults remained low. So, not surprisingly, high-yield spreads have recovered with the rebound in oil. The non-crisis has been averted (from JPM).

Markets climb a wall of worry, but that's not our main message. In real-time, none of the "worries" presented above were valid. That markets shrugged them off is exactly what a rationale and objective investor should have expected.

Why have markets rallied the past two months? There are many reasons but here some of the most salient:

First, equities normally decline and then rebound in the aftermath of the first rate hike from the Fed. That is exactly the pattern we have seen since the first Fed rate hike in late-2015. A post on this from August 2015 is here (chart from BAML).

Second, bear markets rarely take place outside the context of a recession. In those cases that they have, it was a result of a rapid rise in rates or exuberant investors, neither of which applies to the current environment. A post on this from January 2016 is here.

Third, the US economy is doing fine. It's not growing fast, but it is growing and an imminent recession appears to be unlikely. A series of posts on this over the past two years is here (chart from MarketWatch).

Fourth, investor pessimism reached an extreme in February and there has not been much of an improvement since. A post on this from the week of the February low is here and one from last week is here (chart from BAML).

Fifth, corporate earnings were dragged lower in the past 18 months by a combination of falling energy prices and a surging dollar. Both of those seem to have reversed and continued improvement could become a tailwind for earnings in 2016 (chart from Yardeni).


Finally, while it seems clever to list reasons for equities to plunge, the boring reality is that equities rise 70-80% of the time. The natural inclination of the equity market is to go higher over time (table from Schaeffers).

SPY's new all-time high on Tuesday arrived despite falling margin debt, the end of QE, negative household fund flows, flat profit growth and a host of other reasons. In other words, exactly as a rationale and objective investor should have expected.

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Wednesday, April 13, 2016

Fund Managers' Current Asset Allocation - April

Summary: At the panic low in equities in February, fund managers' cash was at the highest level since 2001, higher than at any time during the 2008-09 bear market. Global allocations to equities had fallen from 40% overweight to only 5% in just two months. Since 2009, allocations had only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market.

Since then, equities around the world have risen an average of 14%. Despite this, investors remain defensive. Over the past month, cash balances have risen and allocations to equities have declined. This supports higher equity prices in the month(s) ahead.

Allocations to US equities remain near an 8-year low, a level from which the US should continue to outperform, as it has during the past 12 months. Europe remains overweight. Emerging markets remain underweighted but allocations have jumped significantly in the past three months.

The dollar is still considered overvalued. Under similar conditions, the dollar has fallen in value. In the past two months, the dollar index has fallen 6%.

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Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers cash levels in February were 5.6%, the highest since the post-9/11 panic in November 2001, and lower than at any time during the 2008-09 bear market. This was an extreme that has normally been very bullish for equities. Cash in April (5.4%) is still near the highs and is supportive of further gains in equities.

Friday, April 1, 2016

April Macro Update: Still No Sign of an Imminent Recession

SummaryThe macro data from the past month continues to point to positive but sluggish growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.
    The main positives are in employment, consumption growth and housing:
    • Employment growth is close to the best since the 1990s, with an average monthly gain of 234,000 during the past year.  Full-time employment is soaring.
    • Recent compensation growth is the highest in more than 6 years: 2.7% in December, dropping to 2.3% yoy in March.
    • Most measures of demand show 3-4% nominal growth. Real personal consumption growth in February was 2.8%.  
    • New housing sales, starts and permits remain near an 8 year high. 
    • The core inflation rate ticked up above 2% and to the highest rate since 2008.
    The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):
    • Core durable goods growth fell 1.6% yoy in February. It was weak during the winter of 2015 and it has not rebounded since. 
    • Industrial production has also been weak, falling -1.0% yoy due to weakness in mining (oil and coal). The manufacturing component grew 1.8% yoy.
    Prior macro posts from the past year are here.

    * * *

    Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

    Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

    This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.

    A valuable post on using macro data to improve trend following investment strategies can be found here.

    Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.

    Employment and Wages

    The March non-farm payroll was 215,000 new employees minus 1,000 in revisions. In the past 12 months, the average gain in employment was 234,000. Gains since 2014 have been the highest since the 1990s.

    Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 84,000 in March, as well as the 'disappointingly weak' print in September, fit the historical pattern. This is normal, not unusual or unexpected.