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Motif Market Wrap: Sell in May and go away. Or do you feel lucky?

2 May 2016 in Trading Ideas

Last week, stocks tumbled but commodities shined.

ETF / index Weekly change YTD Comment
First-quarter U.S. GDP growth Up 0.5 percent, just below already low expectations, as business activities weaken.
SPY [ETF tracking S&P 500] -1.3% +1.7% Worst week since February.
VEU [international stock market] -1.4% +1.9% Euro highest since Aug; see here.
XLK [tech ETF] -3.0% -1.1% Disappointing tech earnings most notably from Apple [AAPL]. Facebook [FB]was big bright spot.
Bloomberg Commodities Index Best monthly gain since Dec. 2010.
China purchasing manager indexes (PMIs); more countries will report their PMIs today. The world’s no. 2 economy may be stabilizing but at a slower pace, due to a slightly positive factory activity.

What to look for this week:

Do you feel lucky?
You’ve heard of “sell in May and go away”? It’s a way to say the U.S. stock market tends to see seasonally stronger average returns between November to April than from May to October.

At this juncture in the market where the S&P is teetering near its record high, the question is: “Do you feel lucky?”

if you’ve ever seen that Clint Eastwood movie “Dirty Harry,” you’ll know that line: “You’ve gotta ask yourself one question. Do I feel lucky? Well, do ya punk?”)

Will the S&P 500 soon finally break through to new all-time highs?  Or are investors playing Russian roulette with the market, spinning the chamber one too many times?

Can American consumers lift the U.S. economy?
With first-quarter GDP growth at just below anemic expectations, bullish Wall Street economists are forecasting the same pattern as the prior two years when a stronger second half followed weak first-quarter growth  (seems like these guys feeling lucky too?). The Atlanta Fed’s GDPNow currently expects the economy to grow 1.8 percent in the second quarter while Europe’s first-quarter GDP was better by its anemic standards.

U.S. final demand has been weak due to sluggish business investment, especially in the oil patch, so economists are counting on the mighty American consumer to once again pull the U.S. and global economy out of the doldrums. But is that a good bet? Consumers seem to be feeling less confident these days; with paltry wage growth, it’s hard to  be confident working the low-paying jobs that have dominated employment growth.

From a longer-term perspective, productivity needs to pick up sharply for living standards to rise and for huge debt burdens, including retirement unfunded liabilities, to be met.

More than just luck needed to fix the economic doldrums?
As expected, corporate profits in the first three months of the year are weaker than a year ago. S&P 500 earnings reported so far this quarter are down 6 percent from a year ago, the third straight quarter of negative earnings growth.[1] Bottom-up Wall Street analyst consensus is expecting a big hockey stick increase by the third and fourth quarters, as we showed in our market wrap last week.  Are they feeling lucky?

That depends on how they respond to the many questions are vexing the market. Since July, the S&P 500 has had two corrections that each lost about 10 percent of its value.  Given the 17-times-earnings S&P 500 valuation and currently negative earnings growth, if there is another correction, will it keep going into bona fide bear market territory?  Are the high frequency trading robots that now dominate the stock market feeling lucky enough to spin that chamber one more time?  Or will GDP fail to pick up as hoped for?  Will S&P earnings fail to have a “hockey stick” “stick save”? Will one or more of the myriad potential crises actually happen?

We’re now in the second longest-ever bull market, and as it’s getting long in the tooth, central banks have pulled out all the stops to keep it going. Will their toolbox —perhaps the biggest potential threat to the market is if those tools can’t work their magic — finally be called into question? The Bank of Japan is the current poster child for this seeming lack of potency.[2]

Fed not eager to raise rates; BOJ disappoints
As central banks are front and center in this post-2007-09 crisis era of financial markets, investors hang on their every word. Two key central banks held their meetings last week, and as expected, the Fed did not raise rates and signaled it would be in “no rush to raise rates” at its June meeting. Meanwhile — and less expected — the Bank of Japan failed to deliver the much hoped for monetary stimulus, with immediate disappointments evident in the tumbling Nikkei and rising yen.

Perhaps Japan’s central bank chief Kuroda-san, who seems to like surprises,[3] is trying to save his last bullets for a final suicidal barrage against the inexorable forces of deflation that seem to be pulling Japan toward yet another recession, despite the formerly much touted Abenomics, with former bond king Bill Gross saying “BOJ has gone off a deep end.”[4]

European central bank (ECB) head Mario Draghi, who is in a race to the bottom with BOJ’s Kuroda on negative interest rates, cast the Germans in the role of villains in Europe’s long-running north-south melodrama, saying that his policies are working and the Germans’ teutonic griping about them are only making more monetary stimulus necessary.[5]

Tech-land: Facebook’s massive “network effect”; Apple’s smartphone slowdown
Facebook [FB] once again proved that not all “network effects” are created equal thanks to the blockbuster one it’s got in mobile advertising. This comes after poor earnings reported by Apple [AAPL], the most valuable publicly traded stock, which had its worst week since 2013 . Other tech companies that reported disappointing earnings include Alphabet (Google) [GOOG], Microsoft [MSFT], Twitter [TWTR] and Intel [INTC], which announced layoffs.

Taking a page from the Google boys, Larry and Sergei, Mark Zuckerberg created a new class of non-voting stock to give him permanent control. It seems that being a public company is great, in terms of providing liquidity for stock options, but not so much when it comes to Wall Street’s short-sighted focus on the silly “beat” quarterly earnings game.

Tech is one of the worst performing U.S. sector ETFs so far in 2016, as shown in this performance chart of ETFs. Usually the S&P 500 performs better when tech is near the lead, for the obvious reason that tech is the one dynamic growth sector in our economy. So if tech starts to weaken, the market needs to find strength elsewhere.

Apple’s earnings may be indicative of a slowdown in the global smartphone market, one of the few bona fide growth drivers since the 2007-09 crisis.  At the other end of the size spectrum, massive container ships that carry all those smartphones and other goods from Asian factories are running fewer routes as goods pile up in trading ports.

One group that is starting to bite their nails about the weakness in tech stocks are unicorns, private companies so-called for their pre-IPO, billion-dollar plus valuations. They are worried whether they would be forced to do down rounds of financing with lower valuations than the previous round, threatening to become uni-corpse. See this long recent article by venture capitalist Bill Gurley if you care to get more color on the private tech market.

BlackRock’s Larry Fink more sanguine on China than perhaps its president
Moving onto other potential trouble spots, China remains an uncertainty amid differing opinions on where it’s headed and as Chinese industrial profits improved from the latest round of debt-laden stimulus.

Larry Fink, CEO of BlackRock, the world’s largest asset manager with around $4.7 trillion under management, gave China a 20 percent chance of a crisis down the road, saying that this year should be okay. Former Soros hedge fund manager Bob Bishop agrees with Fink and is betting against his former boss’s negative views on the prospect of a China “hard landing.[6]

But evidently Chinese bond traders don’t fully agree with either as the Chinese debt market has its deepest sell-off in more than a year. Perhaps China’s President Xi doesn’t either, as he has just taken more direct control of its armed forces, often the deciding factor in China politics. See here for an interesting read on the implications of that.

It’s possible that Fink has far better sources on China than most, but some of the supposedly smartest guys in the room, aka hedge funds, have been completely wrong-footed on China this year, among other things, leading to such continued dismal returns that one of their brethren, Dan Loeb, spots another crisis brewing, in hedge funds themselves. By the way, Warren Buffett reiterated his negative view of hedge funds at Berkshire Hathaway’s annual meeting Saturday.

Finally, McKinsey published “Why investors may need to lower their sights,” an important report for anyone interested from a much longer-term perspective. The argument is that long-term investment returns will be poor compared with those of the past thirty years. If you’re a millennial, it’s required reading.

[1] Thomson Reuters

[2] http://www.marketwatch.com/story/bank-of-japan-makes-you-feel-sorry-for-impotent-central-bankers-2016-04-28

[3] http://www.wsj.com/articles/why-the-bank-of-japan-held-fire-for-another-day-1461830549

[4] http://www.bloomberg.com/news/videos/2016-04-27/bill-gross-the-boj-has-gone-off-the-deep-end-with-qe

[5] http://www.bloomberg.com/news/articles/2016-04-27/draghi-tells-germany-criticism-may-slow-return-to-higher-rates

[6] http://www.bloomberg.com/news/articles/2016-04-26/ex-soros-cio-bishop-a-china-bull-betting-billionaire-is-wrong

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  1. Ryan
    3 May at 8:24 am

    Great summary, Hardeep. Just a little long for the average reader but I really enjoyed it.

    Reply

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