Sell in May and go away. We are in that season where you will be blasted with seasonality articles. That's only one-third of this article though. There are actually three things conspiring to drive markets lower soon. Let's talk.
Sell In May And Go Away
This old saying originally had something to do with rich English dudes leaving London to go on vacation in the summer. In America however, it has become a notation of the seasonality that occurs in the stock market.
We know that from May to October is usually the time when the stock market has bigger corrections or is more flattish. We also know that from November to April is when the stock market, on average, makes most of its gains.
I attribute the seasonality, which is not completely regular, to how money flows shape up during different parts of the year. Retirement plan inflows, which occur near year-end (Santa rallies anybody) through tax-day, are prevalent during the historically better seasonal period.
Retirement plan inflows is not the full explanation of why that period is usually better for investing, but it's simple, easy to understand and actually makes a lot of sense. There are some years however, when the winter rally doesn't start until a little later. Last year was one of those years.
At the very start of Q4 last year, I described that we were very likely in for a correction due to the buyback blackout that occurs around earnings, as well as, due to some tax-loss selling. Here's a visual from WSJ:
So, not only do we get slowing retirement plan money into markets, but we will also see a slowdown in buybacks temporarily. A similar reduction in buybacks will occur in July and October as well. This essentially bookends the market with seasonal weakness after a significant rally.
Is that a good or bad set-up? I know my answer. We'll see if retail hopesters and mystery investors can power markets up much the next three months. If they do, I think that only sets up a worse late summer.
Of course, the Fed is supposed to end QT in September. If I were a betting man, I'd think we are setting up for a small summer correction and then a rebound. But, let's think about what if the market does levitate until around year-end. How does that set-up look?
What I am trying to convey is that the short-term is uncertain, but the set-ups just will keep getting worse if the market rises. Here's why.
Slowing Economic Growth
The IMF slightly cut their global growth forecast for 2019 to 3.3% from 3.5% this week. That is a the slowest growth rate since 2009. Yet, markets have seen expanding valuations again after getting within a standard deviation of normal in December.
We know that Europe is in bad shape. Brexit could make it worse. With China slowing, most of the Asian peripheral nations are also slowing. Eric Basmajian looked at trade numbers for China's partners recently and told somewhere between an ambiguous and negative story.
Interestingly the IMF also said there would be a bit of a second half rebound and pateau at 3.6% in 2020. They also said that China could grow an extra 1/10th of a percent this year, a whopping 6.3% instead of 6.2%, which would both be below China's 28 year worst performance last year of 6.6% (that they probably lied about).
What does that all mean? I think it means that the "slow growth forever" global economy is very real. That's a phrase I coined back in my MarketWatch days. Here's a piece at my firm website from a few years ago for a more expanded primer:
The short story on "slow growth forever" is that aging demographics and massive global debt (until we helicopter money it away) are slowing the natural upward trend of a monetary expansionist economy. Deflation is the bogeyman, not inflation.
As I argue repeatedly, we should be stimulating the economy with fiscal policy for about the next two decades and at the same time bailout the retirement system (and might as well bailout student loan debtors too). Why? Because we are getting old and we totally screwed up the world's long-term financial planning over the past four decades.
We won't of course do anything to fix things until something really breaks though. In the meantime, economic growth will slow, even though essentially the entire planet needs to be rebuilt to be sustainable to our very existence.
That slowing growth will put the brakes on valuations at some point. Whether we correct sooner or later, all we know is that the fall will be worse the higher up we get. Here's a chart I put out over a year ago:
Avi and I don't agree perfectly on numbers for the coming correction, but we're pretty close. We don't agree mainly because I just eyeball stuff and worry about the big moves. I do my best to be like Paul Tudor Jones (in my wildest financial dreams )vs Avi who is more like George "the Iceman" Gervin just scoring hoops nonstop.
The point is, slowing growth is a big deal and will damage valuations someday.
Trading On A Conspiracy
We know there is a direct correlation between global trade and economic growth. With the tradewars and tradewar innuendo, as well as, supply chains moving due to technology, trade is struggling to show any growth as of the second half of last year according to the WTO.
Trade fell directly inline with the tariffs imposed on China by the United States. If trade between China and the U.S. does not normalize, that will have dire consequences for global trade. The costs of substitution are substantial.
I have described in my Friday webinars that we are likely to see either a "fake deal" or a no-deal with China.
A "fake deal" is marginal improvements in trade relations with some big orders for "stuff" from the United States by China. Why is that a fake deal? Because it really won't protect IP much or allow American companies significantly more access to the growing Chinese consumer class.
While a fake deal would be good for some, like Cheniere (LNG) which is waiting for a huge Chinese deal, and farmers, it wouldn't be good for many. It would mostly be window dressing that we didn't need to go through this much angst for. Regardless, it's something, and it's basically what my expectations always were.
I never thought we would see a breakthrough deal with China and nothing going on has changed my mind. I had a dissident Chinese professor tell me about the nature of the Chinese trade approach with the U.S. way back in the early 1990s that has held up since then. Essentially, he told me and a few others, that China would always dangle the carrot to get what they want, then give you none of the carrot other than some peelings.
So, it is no secret that President Trump has burned some bridges and is at conflict with a lot of people. His tradewar threats are not taken kindly and President Xi in particular does not like to be pushed around. Here's where the conspiracy theory comes in.
I have discussed in my webinars that I think it is very possible that President Xi strings President Trump along, until about June. Along the way, he will buy what China needs to survive until after the Presidential election. Interestingly, June has now become the target date for a Xi and Trump meeting. Right after oil trade waivers are set to be extended or ended with regards to Iran sanctions.
Follow along here, there's a lot of moving parts. The Iran sanctions impact both China and Saudi Arabia. Saudi Arabia wants to start selling more oil again and China doesn't want to pay a lot. However, neither is ready to end the petrodollar just yet. Why? Because China can't afford for the currency to rise just yet while they continue to be a leading exporter.
Soon though, the petrodollar will end. It's all about timing. If President Trump doesn't give both China and Saudi Arabia what they want, they can push the U.S. into recession next year. One thing President Trump knows is that if the economy is bad, he has very little chance of winning.
So, what does that all mean. I think it means a fake deal with China and Saudi Arabia sells more oil come summer, to both India and China. In turn, that means status quo for markets as the markets have already largely priced in a trade deal of some sort.
Of course, President Trump is a bit mercurial. What if he doesn't want the deal? What if President Xi doesn't want a deal and decides other options are better, i.e. a stronger currency on an oil deal in Yuan with Saudi Arabia?
Does anybody put it past Saudi Arabia and China to do whatever it is they want? What they want might not be rational either. It might boil down to do they think they are getting enough from President Trump to do deals with him on oil and trade.
What Is An Investor To Do?
I hope that all confused you. I have been thinking about it for months and I'm confused.
Bottom line is that "slow growth forever" is real and that will have repercussions. One impact of slower growth is that buybacks eventually must fall from record levels.
I wrote over a year ago that the "buyback bubble would end badly." We are going to be close to matching last year's record stock buybacks, but probably not beat. That's bad. Why? Because institutional outflows are permanent from pensions and some other retirement linked systems.
Goldman Sachs and Wolf Street talked about buyback levels supporting the markets this week. Here's what buybacks have looked like recently:
That is a lot of money into stocks in 2018 and the year ended up down. What if buybacks fall back to say just $600 billion, which would be a record any other year?
Again, I'm not advocating wholesale selling of stocks. But, if you can't divine the next move in the market, and especially if you agree with me that there's a rough patch coming in the next year or two or three, then take a good hard look at your risk tolerance. Compare what you could lose in equities - the answer is half or more quickly - and how much pain your are willing to absorb.
I don't want to feel a lot of pain that might not be able to be recovered - remember, I think the "old economy" is on shaky ground on a secular basis. I am holding around half of my accounts under management near 50% cash right now. That might not be right for you, but it might be.