May 2018

Sell in May & Go Away?

The S&P 500 closed the month of April on a down note at 2648.05. Also, down from the last day of December 2017 which closed at 2674.

Ten-year U.S. government bond yields finished the month at 2.95%. German Bunds of the same duration yield 0.56%. We touched the much anticipated 3.03% level on 4-25-18.

With 53% of companies in the index reporting, 79% beat earning expectations and 74% beat revenue expectations according to FactSet.

This metric was last reached in Q3-2008. Earnings this past quarter are up 23.2%, the best rise since Q3-2010.

The forward P/E on the index is now 16.3x earnings against the 5-year average of 16.1x, the 10-year average is 14.3x.

So, with all this good news what's up with the market volatility and directionless trading?

The U.S. Treasury had to raise $488 Billion in Q1-2018 for budgetary purposes, which is a massive amount of supply. Mortgage backed bond purchases along with Fed buying of Treasury notes is coming to an end.

The Fed decides on Wednesday, May 3 on the course of future rate hikes. Oil prices are up to $68.41 but the index of oil stocks is only slightly higher than where the year began. The same lethargy exists for Gold. Concerns about trade wars and real wars abound but both are low probability outcomes. The U.S. dollar is now rising off its Feb 16 lows, a change in direction from its downward trend all of last year.

The President's approval rating is 42% and the Muller probe continues unabated after more than one year of looking with no significant findings of collusion with Russia.

Concern over peak earnings in 2018 appear misplaced as 2019 earnings estimates are for higher levels once again. We could see another rise as much as 10% in 2019.

A recession generally appears on the horizon with an inverted yield curve, but the current 2 yr-10yr US Treasury spread sits at 46 basis points.

Widening spreads between junk bonds and government debt predict concern for the economy or recession. Indeed, we now enjoy a steady economy, rising profits, low inflation, and a slow but steady rise in interest rates. We are now digesting the big run up in stock prices that began in November, 2016 and peaked in January, 2018 at 2872.87.

That was a top to bottom rise of 37% and we now sit 7.8% below that peak.

Short term interest rates have gone over 2% on bills and 3% on 10-year notes, but 30-year bonds sit at 3.12%.

At $155 in SPX earnings for 2018, we derive an earnings yield of 5.85%. A trade war or military conflict with Iran or North Korea would hurt stock prices.

An impeachment attempt by Democrats, should they win the House of Representatives in November will likely cause a selloff.

We have no crystal ball. However, the economic and profit back drop may well lead to more market gains once this period of indigestion has passed.

A final thought, in 1973 when I began in the investing business, I soon learned about a 4-year cycle to stock market bottoms. They occurred with regularity and were referred to as the" Presidential" cycle. It went back to the 1940's.

For the sake of brevity, the midterm cyclical lows happened in 1966, 1970, 1974, 1978, 1982, 1990, 1994, 1998 & 2002. Exceptions occurred with the "Crash of 1987 " and after the 9-11-2001 attack on America the 2006 low never happened. The Fed after 9/11 altered its patterns of easing and tightening, then after the financial crisis in 2008 we began "Quantitative Easing" which led to powerful new influence on the pricing of bonds and stocks.

It is worth remembering, mid-term election years in the "Presidential Cycle” are often volatile and tend not to overcome their angst until late in that year. This year's volatility may prove to be a lot of sound and fury signifying nothing, 2017 was an exceptional year in many ways and this year looks more like a reversion to the mean or what used to be normal.

In the long run, the U.S. stock market appreciates about 10% on average per year with pauses and infrequent but sometimes steep corrections along the way. Patience is required to capture these gains. Bonds will not get you there given the current level of rates.

Happy May!

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