"Sell In May" - Particularly In Mid-Term Election Years

by Lance Roberts

Last week I discussed that the month of April wraps up the "seasonally strong" investment period of the year and leads two of the weakest months of the year. As the markets roll into the early summer months May and June tend to be some of weakest months of the year along with September.  This is where the old adage of "Sell In May" is derived from.  Of course, while not every summer period has been a dud, history shows that being invested during summer months is a "hit or miss" bet at best. However, before you slip into a warm bath of investment bliss, it is important to remember that just because the data suggests that April will "probably" be a positive return month for the market, there is also the "possibility" it will not.  With a ratio of 43 losing months to 72 positive one, there is a 37% chance that April will yield a negative return. In this past weekend's newsletter, we took this analysis to the next step looking at the statistics behind the old adage "Sell In May And Go Away." As the markets roll into the early summer months May and June tend to be some of weakest months of the year along with September. This is where the old adage of "Sell In May" is derived from. Of course, while not every summer period has been a dud, history does show that being invested during summer months is a "hit or miss" bet at best as shown in the table to the left (click to expand). However, there are many academic studies going back to the 1970’s which have confirmed the pattern as well.  As Sy Harding, via Financial Sense, recently noted an an academic study published in the American Economic Review in 2002 concluded that, “Surprisingly, we found this inherited wisdom of Sell in May to be true in 36 of 37 developed and emerging markets. Evidence shows that, in the United Kingdom, the seasonal effect has been noticeable since the year 1694. The additional risk-adjusted outperformance [over buy and hold] ranges between 1.5% and 8.9% annually, depending on the country being considered. The effect is robust over time, economically significant, unlikely to be caused by data-mining, and not related to taking excessive risk.” Furthermore, a 2012 study of the 40-year period from 1970-2011, published by the Social Science Research Network, also noted that, “Surprising to us, the old adage “Sell in May and Go Away” remains good advice. On average, returns are 10 percentage points higher in November to April semesters than in May to October semesters.” In spite of decades of such studies and overwhelming evidence, the financial media still refers to market seasonality not as fact, but as a "theory." They point out that it’s an “iffy thing”, since some years it doesn’t work out, and investors can be “hurt” by being out of the market in the summer months. Of course, it really isn't the investors that are hurt by being out of the market, but the income statments of Wall Street. While there are some years that have posted sizable gains during the summer months, such years do not invalidate the long term statistical probabilities. As the table shows above, the average annual return from the summer months is significantly poorer than the fall and winter. To show the impact of that performance differential, I constructed the following chart which shows the growth of $10,000 invested in each of the seasonal periods. Adding The Midterm Election Cycle While it seems absolutely clear that one should just cash in their portfolio in April, and come back in November, there are plenty of years where the markets rose during the summer months. With the Federal Reserve still inducing monetary liquidity into the financial markets could this coming summer be one of those positive years?  Possibly.  However, this year in particular adds an additional dynamic to the conversation as it is a mid-term election year which has historically had implications for the stock market in the short term.  According to Jeffrey Hirsch of Stock Trader's Almanac: “Midterm election years are historically prone to bottoms, especially in October and 2014 is also a ‘fourth’ year, which has the fourth best record in the decennial cycle for 132 years. Of the last four midterm election years since the start of the Great Depression (1934, 1954, 1974, 1994) that were also fourth years, only 1954 was impressive.” I discussed this specific issue previously: The powerful rally in 2013, which had no real pause, makes 2014 more vulnerable to a more significant correction. Since 1833, the average peak-to-trough fall in US stocks during a midterm year was -12.76%.  The minimum decline of 0.6% occurred in 1894 while the maximum pullback was -33.8% in 1930.  However, the good news is that these corrections tend to occur in the 2nd and 3rd quarters of the year with an advance heading into year end.   The win ratio for all mid-term election years has been 60% with an average overall return of 4.16%. Midterm election years are also notoriously weaker when Democrats are in control, but in the last 13 quadrennial cycles since 1961, 9 of the 16 bear markets bottomed in the midterm year. However, when the midterm year followed a strongly positive post-election year, as in 2013, the annual return fell to just 2.4% on average.  The chart below, from Stock Trader's Almanac, shows the mid-year correction that generally accompanies a mid-term election year. With the markets falling by an average of 12% since 1833, and 6% since WWII, the summer months of mid-term election years have not been kind to investors. However, let's sum up the risks at play in the markets currently: The Federal Reserve is extracting liquidity from the markets. Interest rates are potentially rising 2013 was an exceptionally strong year for the markets. Markets have gone an exceptionally long period of time without a 10% correction. The "momentum" play has cracked (biotechs, low float stocks) Mid-term election years, particularly when Democrats are in control, have been weak during the summer months. While there is certainly a possibility that this summer could yield a positive return, there are enough concerns to be more cautious than normal. While there is no guarantee that this summer will produce a negative return overall, it certainly doesn't negate a pretty nasty hiccup along the way.

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No One Will Ring The Bell At The Top

by Lance Roberts

The market has had a rough start of the year flipping between positive and negative year-to-date returns. However, despite all of the recent turmoil from an emerging markets scare, concerns over how soon the Fed will start to hike interest rates and signs of deterioration in the underlying technical foundations of the market, investors remain extremely optimistic about their investments. It is, of course, at these times that investors should start to become more cautious about the risk they undertake. Unfortunately, the "greed factor," combined with the ever bullish Wall Street "buy and hold so I can charge you a fee" advice, often deafens the voice of common sense. One of my favorite quotes of all time is from Howard Marks who stated: "Resisting – and thereby achieving success as a contrarian – isn't easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That's why it's essential to remember that 'being too far ahead of your time is indistinguishable from being wrong.') Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it's challenging to be a lonely contrarian." That quote is truest at extremes as markets can remain "irrational" far longer than would otherwise seem logical. This is particularly the case when, despite clear signs of overvaluation and excess, central banks worldwide are dumping liquidity into economies in a desperate attempt to "resolve a debt bubble with more debt." It is interesting that when you ask most people if they would bet heavily on a "pair of deuces" in a game of poker, they will quickly tell you "no." When asked why, they clearly understand that the "risk to reward" ratio is clearly not in their favor. However, when it comes to the investing the greater the risk of loss, the more they want to invest. It is a curious thing particularly when considering that the bets in poker are miniscule as compared to an individual's "life savings" in the investment game. However, that is where we clearly find ourselves today. There was never a clearer sign of excessive bullish optimism than what is currently found within the levels of margin debt. Even as the markets sold off sharply in February, investors sharply levered up portfolios and increasing overall portfolio risk. Even professional investors, who are supposed to be the "smart money," are currently at the highest levels of bullishness seen since 1990.  (The chart below is the 4-month moving average of the net-difference between bullish and bearish sentiment.) Franklin Roosevelt, during his first inaugural address, made one of his most famous statements: "So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself..." However, when it comes to the stock market it is the "lack of fear" that we should be most fearful of.  Throughout human history, the emotions of "fear" and "greed" have influenced market dynamics.  From soaring bull markets to crashing bear markets, tulip bubbles to the South Sea, railroads to technology; the emotions of greed, fear, panic, hope and despair have remained a constant driver of investor behavior.  The chart below, which I have discussed previously, shows the investor psychology cycle overlaid against the S&P 500 and the 3-month average of net equity fund inflows by investors. The longer that an advance occurs in the market, the more complacent that investors tend to become. Complacency is like a "warm blanket on a freezing day."  No matter how badly you want something, you are likely to defer action because it will require leaving the "cozy comfort" the blanket affords you. When it comes to the markets, that complacency can be detrimental to your long term financial health. The chart below shows the 6-month average of the volatility index (VIX) which represents the level of "fear" by investors of a potential market correction. The current levels of investor complacency are more usually associated with late stage bull markets rather than the beginning of new ones. Of course, if you think about it, this only makes sense if you refer back to the investor psychology chart above. The point here is simple. The combined levels of bullish optimism, lack of concern about a possible market correction (don't worry the Fed has the markets back), and rising levels of leverage in markets provide the "ingredients" for a more severe market correction. However,  it is important to understand that these ingredients by themselves are inert. It is because they are inert that they are quickly dismissed under the guise that "this time is different." Like a thermite reaction, when these relatively inert ingredients are ignited by a catalyst they will burn extremely hot. Unfortunately, there is no way to know exactly what that catalyst will be or when it will occur. The problem for individuals is that they are trapped by the combustion an unable to extract themselves in time. I recently wrote an article entitled "OMG! Not Another Comparison Chart" because there have been too many of these types of charts lately. The reason I make that distinction is that the next chart is NOT a comparison for the purposes of stating this market is like a previous one. Rather, it is an analysis of what a market topping pattern looks like. As you can see, during the initial phases of a topping process complacency as shown by the 3-month volatility index at the bottom remains low. As the markets rise, investor confidence builds leading to a "willful" blindness of the inherent risks. This confidence remains during the topping process which can take months to complete. With individuals focused on the extremely short term market movements (the tree) they miss the fact that the forest is on fire around them. However, as shown, by the time investors realize the markets have broken it is generally too late. As Seth Klarman recently wrote: "The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented. But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs. Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared." It is in that statement that we find the unfortunate truth. Individuals are once again told that this time will be different. Anyone who dares speak against the clergy of bullishness is immediately chastised for heresy. Yet, in the end, no one will ring the bell at the top and ask everyone to please exit the building in an orderly fashion. Rather, it will be "Constanza moment" as the adults (professionals) trample the children (retail) to flee the building in a moment of panic. It is only then that anyone will ask the question of "why?"  Why didn't anyone warn me? Why did this happen? Why didn't we see it coming? Why didn't someone do something about it?

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Citi Warns The Leverage Clock Is Ticking

Tyler Durden

Citi's credit strategy team warns, for non-financial corporations - fundamentals have turned. Low interest rates hae helped keep debt service burdens low but, as they suggest, releveraging tends to sneak up on you. Leverage is as high as its ever been outside recession. This may not be a problem today, or tomorrow, but the leverage clock is ticking... and credit markets have no room for downside surprises (and, as we have vociferously explains, if credit spreads rise as the credit cycle 'cycles' then the underpinning for the entire buyback/dividend driven 'fudge' for stock valuations is removed)... and risks seem far higher in the US (than Europe) going forward. The leverage clock is ticking... But releveraging tends to sneak up on you... Leverage is as high as Citi has seen outside of recession... and credit is not priced for any risk... Any growth slowdown and leverage is in trouble... Which leaves the US a lot more at risk than Europe... We have seen this "credit cycle end, equities ramp" before - in 2007 - where leverage (both firm-wise (debt/EBITDA) and instrument-wise (CDOs)) provided the extra oomph to send stocks higher on the back of credit fueled extrapolation of earnings trends. (charts: Barclays) In the end we know this is unsustainable - the question is when (in 2007 it lasted 10 months or so...). Of course, just as in 2007, things change very quickly once collateral chains start to shrink. Perhaps this is why Carl iCahn called the top - because he knows the ability to re-leverage (his bread and butter trade) is over...

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One-Third of S&P 500 Companies Report No Revenue Growth

By Michael Lombardi

Those who follow the stock market closely know that on days when we hear the chairwoman of the Federal Reserve speak and she mentions something about “easing” or how the central bank will continue to use its “extraordinary measures” for a long period of time, the stock market jumps. I’ve talked about this phenomenon many times in these pages. Another example of this happened on March 31, when the Fed chairwoman spoke in Chicago. Please see the chart below. It’s a minute stock chart of the S&P 500. I’ve circled a rough area around the time when Janet Yellen spoke. Chart courtesy of www.StockCharts.com As she spoke more of that “easing” talk, the stock market jumped, as usual. So it has come to the point where the stock market rises when it hears the Fed will keep interest rates artificially low for a prolonged period of time and when a poor jobs report comes out (like last Friday morning’s), saying jobs have been created in spite of the fact that there is a heavy concentration of jobs growth in low-paying sectors and millions of people have given up looking for work. In other words, we have reached the point where the stock market takes any news as a reason to move higher; this is characteristic of a market top. When we look at the fundamentals of the stock market, we see companies in the S&P 500 are using financial engineering to boost per-share earnings. These companies have bought back their shares and have been cutting costs to boost profits as revenue growth just isn’t there anymore. The proof? In the fourth quarter of 2013, 28.8%, or 144, of the S&P 500 companies reported an outright decline or no change in their revenue from the previous year. (Source: S&P Dow Jones Indices, last accessed April 2, 2014.) And so far, for the first quarter of 2014, 93 of the S&P 500 companies have issued negative corporate earnings guidance for their first quarters of 2014. (Source: FactSet, March 31, 2014.) This is a fact that shouldn’t be taken lightly: one-quarter of the S&P 500 companies have warned on corporate earnings for the quarter. A stock market spinning any news into good news so it can rally while the stocks that trade on the stock market are posting earnings growth at the slowest pace since 2009 is a risky stock market.

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CORPORATOCRACY

By: BATR

Record US corporate profits are the beneficiary of easy money, near zero interest rates and monopolist aided government tax policies. The upward surge in earnings since the depths of the financial collapse proves one incontrovertible fact; namely, tax regulations, implemented to aid favorite companies, is the operational model of the corporatist economy. Americans for tax fairness for 2013 report on 10 Companies and Their Tax Loopholes. Included in this examination on Bank of America, Citigroup, ExxonMobil, FedEx, General Electric, Honeywell, Merck, Microsoft, Pfizer and Verizon, indicated "corporations have stepped into the fray with some of the most aggressive lobbying we’ve seen in years – calling for cuts to corporate tax rates, a widening of offshore tax loopholes." "In making their case, corporate executives decry the U.S.’s 35% corporate tax rate claiming it is the highest in the world and makes their businesses uncompetitive globally. The evidence suggests otherwise. Corporate profits are at a 60-year high, while corporate taxes are near a 60-year low. U.S. stock markets are at record levels, and American CEOs are paid far more than executives who run firms of similar size in other nations. Many U.S. corporations pay a higher tax rate to foreign governments than they do here at home." This economic fact, regularly ignored in the business press, clearly represented in the New York Times article, Abolish the Corporate Income Tax by Laurence J. Kotlikoff, speaks for itself. "Eliminating the United States’ corporate income tax produces rapid and dramatic increases in American investment, output and real wages, making the tax cut self-financing to a significant extent. Somewhat smaller gains arise from revenue-neutral corporate tax base broadening, specifically cutting the corporate tax rate to 9 percent and eliminating all corporate tax loopholes." Sentiment such as this snubs the fundamental harm done, to the domestic economy and the middle class, from the offshore transplant of good paying American jobs. At the heart of this deception, two key details, demonstrated by the Center for Effective Government, reflects actual employment outcomes. One of the most enduring myths in Washington D.C. is that if we cut taxes on corporate profits, job creation will follow. U.S. corporations have been reporting record profits, even as they pay the lowest levels of federal income taxes in half a century. Large corporations pay, onaverage, just 12.6 percent of their profits in federal income taxes, yet we continue to have nearly 11 million Americans unemployed half of them for more than sixmonths. When corporations don’t pay their fair share of taxes, others must pick up their share of the cost of government. In the 1950s, corporate income taxes paid nearly a third of the federal government’s bills; in 2012, corporate income taxes accounted for less than a tenth of federal government receipts. As corporate taxes as a share of government tax receipts has shrunk, individual income and payroll taxes have risen steadily. So has the budget deficit. Applying this historical comparison, the easiest implication to draw is that corporations have excelled at evading paying taxes, by utilizing legions of tax attorneys, CPA accountants, political lobbyists and campaign donation operatives. However, the federal government has continued to function with outrageous tax deficits as a matter of course within modern memory. Consequently, tax policy does not operate as a means to secure revenue to balance out government expenditures. The Negotium essay, U.S. Corporate Tax Rate Consequences, documents the adverse consequence of the "Free Trade" paradigm and the implication of corporations holding profits in oversea subsidies as part of their tax reduction strategies. Again, this segment is part of the equation, but does not provide the entire solution. The most basic core obstruction is that the courts grant corporations personhood under the law. "Corporations are not people and should not enjoy the protections of constitutional personhood. However, the corporate tax rates needs to reflect the commitment to rebuild America. In the end, the consumer pays the tax." This erroneous legal cover facilitates the great race among corporate titans that avoids public responsibilities as they acquire their lesser competitors and consolidate into "Too Big to Fail" operations. The most aggressive managements create the tax loopholes, which tailor regulations, specifically designed and legally framed to apply to their own businesses, while often marginalizing rivals within their own industry or service enterprises. So what do you get from such interlocking directorships between mega business endeavors and the merger of state regulatory compliance agencies? The perfect business climate to stamp out any contender that dares threaten market share or revenue margins, that comes out of this formula effectively guarantees profits and the shifting of tax burdens onto the public or continued deficit financing of the national debt. As long as the tax code incorporates incentives and costs that seek changes or unnatural advantages in the marketplace, the invisible hand of Adam Smith is shackled to the governmental bribery culture of the political class. Even a proponent of a Living Democracy Movement, David Korten makes this point in, When Corporations Rule the World, "Proponents of corporate libertarianism regularly pay homage to Adam Smith as their intellectual patron saint... Smith had a strong dislike for both governments and corporations." Loopholes are not oversights in legislation or regulatory rules. Most are intended paybacks to the governance plutocracy. The net result of such an alliance, summed up in the Totalitarian Collectivism series, Part 8 – CORPORATIONS and LAW, denotes that more than setting a fair tax rate is at stake. "The craze to legislate, regulate and codify every facet of human conduct, while exempting corporations from public sanctions for the most egregious conduct, is only possible because the law officiates as a silent partner in the boardroom of a criminal syndicate. Admiralty Law functions as the corporate arbitrator for rigged exchanges, destructive trade treaties and capitalist dictators. Citizens are sacrificial lambs on the altar of "TC" conformity and compliance. As practiced in America, the corporation reigns supreme and the law protects State Capitalism at the expense of ordinary people."

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US Households To Withdraw $430 Billion From Stocks In 2014 - Most Since Last Bubble

by Tyler Durden

When it comes to the conventional wisdom of who owns the bulk of corporate stock in the US equity market, the consensus is simple: at 36% of total, the answer is the US household. This is shown in the chart below. As an aside we disagree from this simplistic analysis because as is well known, the "Household" category, which is pulled from the Fed's quarterly Flow of Funds report, is merely a placeholder plug, designed to balance out all the other member categories. What is less known is that entities such as hedge funds use extensive "off the books" leverage (just ask Citadel and its nearly 9x regulatory leverage) to hold far more equities than their capital allows them. Which means that in reality the US household owns far less stock than is believed. But even if one takes the Fed's data at face value, what becomes clear is that having owned virtually the entire stock market in 1945, households are now down to nearly their lowest fractional ownership in history, with the rest alloted to mutual, pension and retirement funds. And it is only going to get worse. According to a recent analysis by Goldman, in 2014 the US household is on track to withdraw a whopping $430 billion from US corporate stocks. i.e., sell. This will be the biggest net outflow by the Household group, which has constantly withdrawn cash from equities over the past decade, since the last market peak. It is understandable why: with baby boomers retiring in droves, and with interest income non-existent, investors are forced to liquidate positions in order to generate, well, liquidity. Perhaps a more disturbing question is why is the household outflow not bigger? After all it surpassed $1 trillion during the last market peak. Could it be because households just don't have all that much equity left in a market which is now dominated by a mere tiny fraction of the entire US population? But the biggest question is with household pulling cash out, who will provide the offsetting inflow into stocks? The answer: corporations of course - the same entity that injected a record $500 billion in stocks in the form of buybacks is set for another bumper year of net inflows, and according to Goldman companies are on par to match their 2013 buyback activity by buying back some $450 billion of their own stock in the coming year. This also expains why for one more year, there will be no capex rise - quite simply in order to maintain the illusion of the stock market ponzi, corporations have to keep buying back ever greater amounts of their own stock in order to keep reducing the denominator in the EPS fraction and perpetuate the myth that Net Income is growing when in reality only the number of outsanding shares is declining. So for all those hoping for that so long overdue CapEx bounce, may we interest you in some 1000+ forward PE multiple stocks. After all in a ponzi which has already likely passed its Minsky moment, the only "trade" that works is to bet on the greatest fool of all, the Fed.

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