Sell in May and go away?
May was a difficult month for equities across the board, as investors seemed to heed the “Sell in May” maxim.
- The S&P 500 Index was down 6.01 percent.
- The Nasdaq fell 7.19 percent.
- From a fundamental perspective, there were no changes that would justify the decline.
- Corporate earnings remained strong.
- Valuations, based on trailing earnings, continued to appear reasonable.
- Technically, though, the market has shown significant weakness.
- The S&P and the Nasdaq moved below their 50-day moving averages and close to their 200-day moving averages.
- It could mean we’re in store for continued weakness.
International markets fared worse in May, partially due to the weakness of the euro and other foreign currencies relative to the dollar.
- The MSCI EAFE Index was down 11.48 percent.
- The MSCI Emerging Markets Index was off 11.67 percent.
- Like the U.S. markets, trailing fundamentals showed no significant changes.
- The deterioration of the European macroeconomic outlook and a slowing Chinese economy implied that future results might well be below initial expectations.
- Technically, both indices have been below their 50-day moving averages since April, and they each moved decisively below their 200-day moving averages in early May.
U.S. Treasuries continued to do well.
- Yields on U.S. government securities remained stable for shorter maturities and dropped to new lows for longer maturities.
- Municipal spreads remained level, while corporate and high-yield spreads widened.
- The Barclays Capital Aggregate Bond Index returned 0.90 percent for the month, and the Barclays Capital U.S. Corporate High Yield Index lost 1.31 percent.
The common factor among these return patterns is the resumption of the risk-off trade.
- The worsening consensus outlook for multiple large economies across the world contributed to a demand for so-called safety assets instead of riskier equities.
- U.S. assets—Treasuries in particular—led the way.
The pain in Spain
Driving the risk-off trade is Europe and the eurozone economy, which has begun to contract.
- Results varied by country, but overall demand slowed dramatically in May.
- Even historically strong countries like Germany are expected to see stagnating growth, as exports to other countries fall.
- The financial economy showed worrying signs as well.
- The Spanish banking system continued to show signs of stress, and Spanish interest rates increased over the month.
Then there’s the uncertain political backdrop, where the German-sponsored consensus of austerity is under threat.
- At the end of May, Ireland apparently approved the European fiscal pact, committing the country to continued government spending cuts and austerity.
- But Greece has a new round of elections scheduled for mid-June, which may or may not support the earlier austerity commitments the country made to receive bailouts.
- Overall, the consensus of two months ago, which was based on the premise that the European problem was on the way to being solved, showed substantial cracks in May.
Negative signs are also coming out of China.
- Projected growth is slowing and nearing levels that have created problems in the past.
- This means that another potential growth engine will not be there to bolster either the global or U.S. economy.
- Continued weakness in Europe is also a negative factor for China.
U.S. economy continues to plod along
Unlike Europe, the U.S. experienced modest economic growth, and data from April, released in May, suggested that while growth was slowing somewhat heading into summer, the economy still appeared to be on track.
- A slowdown in employment growth grabbed our attention but the numbers were still positive.
- Consumer spending continued, but a decline in personal saving could be cause for concern.
Although there were many mixed indicators, two components of support stood out.
- Housing starts, sales of new homes, and sales of existing homes continued to increase in April, suggesting a broad bottoming in the market.
- Many markets are seeing price increases, and on a seasonally adjusted basis, the national indices are showing price increases as well.
- Housing is a foundational component to recovery, and although risks remain, the breadth of the positive data is a good sign in our view.
- Like housing sales, vehicle sales have a large supply chain and a high multiplier effect.
- Bloomberg reported that U.S. auto sales are on pace to achieve their best rate since 2007 and are in their third year of double-digit increases.
Overall, although the U.S. economy remains subject to substantial risks, the base expectation is that slow growth will continue.
- Most of the risks are noneconomic, with the largest being the pending “fiscal cliff” at the end of this year.
- Many tax and spending changes are scheduled to take effect if Congress takes no action to stop them.
Time for caution, not panic
Despite the deep problems in Europe, and potentially in China, the U.S. remains in a strong, competitive position.
- A strong and growing base of domestic demand will hopefully support growth, and exposure to global troubles via exports is limited.
- Even the links we do have, such as the banking system, have reduced their exposure over the past year or so.
- With 10-year U.S. Treasuries at multiyear lows, the markets are saying that the U.S. market may be one of the safest on the planet.
- While the volatility of the past month has been unsettling—and may continue—we believe that the U.S. remains one of the best places to be over the medium to long term.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.