Finance

Selling in May?

PaulNolte-2“Two roads diverged in a wood, and I took the one less traveled by”, so ended Robert Frost’s “The Road Not Taken”. The financial markets are looking very much like those two roads diverging, as the big US stocks diverge from their OTC brethren. Given all the background noise of slowing economic data from China, Russian saber rattling and US economic data coming in below estimates, it is little wonder that the markets are struggling to find their footing. The biggest worry in the US is the noticeable slowing in the housing market. Existing home sales are at their lowest level in nearly two years, while refinancing activity has stagnated. Lumber prices reflecting the weaker demand, are 20% below last year’s peak and 10% below this year’s highs. On the sunny side of the street, durable goods were well above expectations as was the Fed’s regional economic activity reports. China’s economy continues to show weakness, reflecting overall weakness in their export partners (primarily Europe). The coming week is loaded with economic and earnings data along with a Fed meeting capped by the monthly employment report. Investors may do well to take the road deep into the woods this week!

The OTC market has been the poster child for those calling for a major correction in the markets. Already down 7% from their February peak and led by the now former market darlings (biotech and social media), many are expecting that weakness to pull the rest of the market with them. The markets have rotated toward the more defensive parts of the markets, including utilities and energy. Since they represent a very small portion of the overall market, their strength is not holding the broader averages up. When looking only at the companies within the SP500, most of those stocks are rising rather than falling. Investors are also listening to the siren song of “sell in May and go away”. However, last year the markets rose by 10% during that period. The market is and has been for some time, ripe for a 10% correction. This could indeed be the year for that, however there doesn’t yet seem to be a preponderance of evidence pointing in that direction. Continued big daily swings and weekly dramatic sideways movements are more likely in the months ahead. Last week was a perfect example, as the SP500 fell on the week, yet more stocks rose than fell. Just didn’t feel like good week as Friday’s decline left investors with a bad taste heading into the weekend.

For all the excitement in the stock market, the bond market continues to be the model of stability. The longest and most volatile maturity, the 30-year, has steadily declined all year, falling half of one percent so far in 2014. The betting going into the year was that rates, having increased by nearly a percentage point from last April to December, were well on their way to much higher levels in 2014. Lacking significant inflationary pressures and wage growth, it is hard to see persistent inflation beyond the normal yearly moves in food and energy prices. The California drought is certainly a concern for food prices, but as we experienced in the Midwest, that too will eventually pass.

The road less taken may also apply to the various asset classes and industry groups within the market. Last year the big winners were the small cap stocks and the SP500. We opined at the beginning of the year that they were unlikely to repeat their stellar performance. Last year’s losers (commodities and bonds) are the early winners this year. Even over the past two years, bonds and commodities were among the worst sectors to invest in, while the SP500 and small cap were the best. It is normal for investors to want to own what has recently done well, figuring the past will continue on into the future. Unfortunately those parts of the market that have done well for an extended period of time tend to be also the most richly priced assets. For example, the small cap index is now selling at their highest valuation in nearly 20 years. The future prospects are already baked into the small-cap valuation, leaving little room for further appreciation. Commodity prices have spent the last three years going nowhere and could spend the next year or two surprising investors on the upside. That doesn’t mean just buying gold, but a broad basket of commodities that include grains, energy and meats.

Investors are focused upon selling in May and taking a long summer break. That may indeed work this year, but there are other parts of the market that look much more interesting than holding onto cash. Bonds continue to provide solid returns as economic growth remains low by historical standards. Although commodity prices could move higher over the course of the year, without wage growth, higher prices may not persist for a long period of time.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.