Setting Up For a Summer Rally?
Even if stocks hit a few speed bumps, they are showing signs of renewed strength that could propel the market higher in the summer months.Something happens this time of year, as the weather improves (it's still bloody cold for May!), people start seeing things, perhaps hallucinating of better days ahead.
Instead of talk about stocks bottoming, there's more chatter recently about new highs, as small caps flirt with their former highs and money is jumping in to tech after this spring's washout.
"I think the incremental positive is we broke the string of lower highs that's been in place since January. Our take is the correction that began in January is coming to an end," said Ari Wald, technical analyst with Oppenheimer.
A number of analysts say ignoring the "sell in May" phenomena this year should be a good thing.
"I think you're seeing leadership reassert. Twenty-five percent of the market cap — tech — is now doing better. The fact we've seen small-cap outperformance is reflective of a market that does seemingly want to take on some risk," said Keith Parker, chief U.S. equity strategist with UBS.
Last week, investors "moved back to an old friend: tech," wrote Jefferies analysts. Tech ETFs took in $774 million last week, while the QQQ, representing the Nasdaq 100, pulled in $1.3 billion, the analysts noted. More than $1 billion also poured into small-caps.
Parker also said the market stands to gain going into the summer simply on the sheer power of corporate buybacks. Buyback announcements are up 80 percent this year, and the actual buybacks are up about 50 percent, according to UBS. Corporations should be buying stock back for the next few weeks until the quiet period ahead of earnings in June, he said (click on image).
The market is not without risks, and those things that have been worrying it — trade wars, higher interest rates, geopolitical tensions — have not gone away. Oil prices could become a brake on market gains at some point, but so far stocks have taken a near four-year high in oil prices in stride. But if Middle East tensions set off an oil price spike, that would be a worry for stocks.
Analysts say the fears about trade wars, however, seem to be fading, in part because it appears there will be a new NAFTA agreement.
Also, President Donald Trump appears to have eased his stance toward China, after his weekend tweet on ZTE, and there are now signs the two countries are moving toward a deal that could give the company a reprieve from U.S. sanctions.
The more positive news on trade helped push stocks higher Monday. But the small-cap Russell 2000 ran against the trend, giving back gains after touching an intra-day high of 1,614, just a point below its all-time high. The index closed down 6 at 1,600.
The S&P 500 was higher on Monday by 2 points, at 2,730, and is now up 2.1 percent year-to-date, though 5 percent below its all-time high. Energy led with a 0.6 percent gain on higher oil prices, and technology was flat. In the last month, S&P technology has risen about 6 percent, while energy is up about 8 percent.
Ryan Detrick, LPL Financial senior equity strategist, said the fact that the S&P 500 turned positive for the year during the month of May is a positive signal in itself. He looked back at the 36 times the S&P was positive for the year on a total return basis at some point during the month of May. He found that it ended the year higher, on a total return basis, 35 out of the 36 times.
Detrick said it could be an easy leap for the S&P 500 to reclaim its old high.
"We think it definitely could happen sometime this summer. The small-caps leading is very powerful. The last time we saw something like this with the small-caps breaking away was January 2013 ... that was not the worst time to be bullish over the next six months or so," he said.
He said the market should be able to defy the old adage "sell in May," a warning that comes with concerns that the second part of the year, specifically between May and October, is weaker.
Robert Sluymer, technical analyst at Fundstrat, said the market could see a brief pause or move lower before a summer rally. But he also sees the market getting back to its uptrend after the winter and spring correction.
"I do think the S&P retests its old highs, as we move into Q2 and into Q3. Beyond a near-term pullback, you're going to see large-caps retest their old highs," Sluymer said.
But Wald sees weakness later in the summer after weeks or months of gains. As investors consider the mid-term elections in late summer, stocks could get choppy but resume their move higher later in the year.
"There are some things that could jump in the mix and throw cold water on market sentiment, primarily politics," said Katie Nixon, chief investment officer at Northern Trust's Wealth Management unit. "We're coming up to midterm elections." She said investors could worry that a change in congressional makeup, ending GOP majorities, would also reverse or end some of Trump's market-friendly policies.
"There's some potential noise that could work its way into the system. If you look beyond the summer, we're talking about healthy earnings" as well as a Fed that will not be moving quickly. "That's typically a really good environment for risk assets," said Nixon.
Parker said other positives are that inflation is relatively contained, so the Fed won't be pushed to hike interest rates more rapidly. "Growth is picking up through the third quarter as fiscal stimulus works its way through, and earnings continue to deliver and corporate buying is strong," he said.
He said even with the 23 percent growth in first-quarter earnings, there have not been that many upgrades to the second, third or fourth quarters, even to just reflect the base effect of first-quarter gains, so there could be earnings beats that continue to boost the market.
On Friday, I went over why some hedge fund managers are betting against stocks. I told you I'm lukewarm on the S&P 500 (SPY), don't think it's the end of days for markets or sell in May and go away, but doubt we will make new highs this year (click on image):
But I also told you to pay attention to the US dollar (UUP) here because after surging recently, it might stall, giving a break emerging market stocks (EEM) which have been pummelled this quarter and allowing commodities (DBC) to continue rallying (click on images):
The surging US dollar has been helped by the yield on the US 10-year US Treasury note (^TNX) which touched a yearly high of 3.09% on Wednesday, sending US long bond prices (TLT) close to a 52-week low (click on images):
Remember, bond yields and bond prices are inversely related, the higher the yield, the lower bond prices go.
So, where is that second half slowdown I've been warning my readers of? Do I still think US long bonds (TLT) will offer great risk-adjusted returns going forward?
You bet but the market is still phishing for inflation phools -- and there are plenty of them out there -- and the myopic focus on commodities rallying despite the rally in the US dollar is emboldening the inflationistas.
But there is one problem, commodities are not a leading economic indicator. It's even questionable how good they are at leading inflation which is a lagging economic indicator. Indeed, commodities have been misunderstood and far too many investors looking at them rallying are mistakenly believing global growth is picking up and this will prove to be a costly mistake.
What I find fascinating is the rally in energy shares (XLE) as they get set to print a new 52-week high (click on images):
The same goes for metal and mining shares (XME) which have also rallied recently and are close to their 52-week high (click on image):
I'm on record stating the rally in energy stocks is not sustainable going forward, and I haven't changed my views.
Moreover, the market is worried about oil and rates but it's quite shocking how few people think about the effects of rising gas prices on the US economy:
If gas prices stay roughly where they are now, it'll wipe out about one-third of the extra take home pay coming from the tax cuts this year. https://t.co/0mSuolbvgm— Lisa Abramowicz (@lisaabramowicz1) May 13, 2018
Higher short-term rates and higher gas prices will cool the US economy, driving long bond yields lower in the second half of the year. And if the Fed continues hiking rates, we risk seeing an inverted yield curve. This is why I keep warning my readers not to ignore the yield curve.
The other thing I keep warning investors about is to watch high yield bonds (HYG) closely, the canary in the coal mine (click on image):
So far, they have behaved well, allowing corporations to easily finance their buybacks, a big factor behind the rising stock market. But if rates rise and high yield bonds get hit as companies default, watch out, it will spell trouble for stocks and other risk assets.
I don't even think rates have to rise a lot. What if the global economy stalls and defaults rise? This scenario will also clobber risk assets.
All this to say, I'm trading individual stocks and having a great year but my macro views have not changed. I'm preparing for a second half global 'synchronized' economic downturn, and as such I'm recommending investors to trim risk in their portfolio by investing at least 50% in US long bonds (TLT) and overweight consumer staples (XLP) and interest-rate sensitive sectors like utilities (XLU), telecoms (IYZ) and REITs (IYR) and underweight cyclical sectors like energy (XLE), financials (XLF), metals and mining (XME), industrials (XLI) and emerging market shares (EEM).
You can trade emerging market shares and cyclicals like banks, energy, metal and mining shares -- basically, all plays on global growth -- but it's risky and your timing better be good because when the tide turns, it's going to be very painful.
The same goes with technology stocks (XLK) where a lot of hedge funds hide out. They've come back strong after the Facebook ruckus but I would be very careful here (click on images):
What are the risks to my scenario? There are a couple:
- I might be wrong, global growth might not be crumbling, just pausing before it reverts back up. I would need to see global PMIs reversing course and heading back up to change my views.
- The yield on the US 10-year could then reach 4% and risk assets, including stocks, corporate bonds and commodities will continue rallying despite the Fed rate hikes. Think back to 1999, the Fed was hiking and stocks kept melting up. I know there is plenty of liquidity out there but strongly doubt this melt-up scenarario will materialize.
All this to say, as summer approaches and the weather warms up, there may be a summer rally but be careful and be nimble, especially if you're trading emerging market shares and cyclicals like banks, energy, metal and mining shares.
Below, will the chip trade heat up again? CNBC's Dominic Chu , Melissa Lee and the Options Action traders, Carter Worth, Mike Khouw & Dan Nathan report on the comeback.
As shown below, semiconductor shares (SMH) are coming back after a pullback but shares of NVIDIA Corporation (NVDA) remain below their 52-week high after getting hit recently (click on images):
NVIDIA’s shares popped after it crushed its numbers last Thursday but then sold off. I'm not willing to bet on chip stocks at this time and fear that a global slowdown will crush a lot of them going into year-end.