Sell in May if Fed Steps Away
With much of the earnings season now in the rearview mirror, the focus of the markets have swung dramatically to every tidbit of economic data and begun speculating on the market makeup once the end of QE 2 is complete at the end of next month. A rather quick and cursory review of the economic condition of the US, as well as the world may give us some insight into the picture of the financial markets over the summer months. The only true guide investors have is the end of QE 1 last spring, which doesn’t provide a range of outcomes from which to begin drawing conclusions. One incident is impossible to draw conclusions from, but such is the world we find ourselves – the subject of a grand economic experiment that has severe implications if the outcome misses the desired mark. The road we are now taking has but a few “exits” that may allow for a policy revision, however the longer we “stay the course”, the fewer those exits we’re likely to see and more certain the outcomes will be.
If we are looking at the US economy to begin determining overall strength, one should start with employment. The employment growth and unemployment rate remain well off the mark for this part of the economic cycle, however some comparisons between the current recovery is beginning to look similar to that of the past recession of ’01-’03. The chart below courtesy of Calculated Risk highlights the Post WWII recession periods of employment deterioration and growth.
In an attempt to put a smiley face on a rather dour looking chart, the current recession is beginning to parallel that of the ’01-’03 recession and if that past is prologue, the economy should get back to the zero line in roughly 3 - 3 ½ years from today. Draw your own conclusions for the implications on the coming Presidential election. Checking out today’s release of weekly jobless claims shows that claims remain fairly sticky above 400,000, indicating that employment growth may be slower than the ramp we saw in 2003. During that period of time, claims spent the better part of 2 ½ years above that 400,000 level compared to today, where claims have spent nearly the entire period from July of 2008 to today above that demarcation line indicating job losses vs. job growth.
The second part of employment is earnings, not of the corporations, but the employees. When looking at hourly growth, using the government data provided by the Bureau of Labor Statistics (BLS), annual changes are touching the 2% level for only the third time over the past 25 years. (Mid-’86 and end of 2003 are the others). When looking at wage growth adjusted for headline (not core) consumer prices, it should come as little surprise that wage growth since the mid-70s have regularly trailed inflation. So the broad swath of employees (read consumers) have struggled to keep up with overall price gains, however once food and energy (the most frequently purchased items) are stripped out, wages have consistently been above core inflation for the past 15 years.
More remarkable is that when we look outside of our borders interest rates have been rising to tamp down the rising inflationary pressures. Here in the US, the Fed is stuck at near zero and not showing signs of changing their stance anytime soon. The knock-on effect of higher rates abroad is to keep pressure on the US dollar, which in turn pushes many commodities higher – as they are priced in dollars. We may be caught in a circular inflationary argument: the dollar declines, pushing commodities higher, pushing inflation higher around the world, forcing central banks to raise rates that push down the dollar and so it goes….Until the Federal Reserve here is willing to increase rates, the dollar may be at the mercy of foreign banks desire to quell domestic inflation.
The point of the above explanation is this: the US economy has become a drug addict (cheap/free money) that is not treating the pervasive disease of too much debt. Additional liquidity in the form of additional quantitative easing (QE 3 or more) will not solve the debt problem any more than did QE 1 or 2 did over the past 18 months. The financial markets were the primary beneficiary of the cheap money that once removed, may cause the normal addictive withdrawal symptoms during the summer months if the Fed is willing to step aside to assess whether additional intervention is needed. The markets are already signaling a change in the guard as commodity prices have come down, defensive sectors have increased and bond prices have also rallied – all similar to the market action of last summer. So while investors have only one data point to judge financial markets action at the end of quantitative easing (part 1), they are acting in a similar fashion – expecting the same results once the Fed steps aside in six weeks. Selling in May and going away maybe a successful strategy again this year as it was last year.
About Paul J Nolte CFA
Paul J Nolte CFA Archive
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