Sell In May and Go Away?

Yun Li and Thomas Franck of CNBC report the S&P 500 rebounds more than 1%, ends the volatile week flat:

U.S. stocks rebounded on Friday as Wall Street reassessed concerns arising from news that the White House could seek a hike to the capital gains tax.

The Dow Jones Industrial Average gained 227.59 points, or 0.7%, to 34,043.49 amid a jump in Goldman Sachs and JPMorgan shares. The S&P 500 rose 1.1% to 4,180.17 led by financials and materials, while the tech-heavy Nasdaq Composite climbed 1.4% to 14,016.81.

The S&P 500 closed the turbulent week with just a 0.1% loss, while the Dow and the Nasdaq fell 0.5% and 0.3% for the week, respectively.

Wall Street came off a turbulent session for equities after multiple news outlets reported Thursday afternoon that President Joe Biden is slated to propose much higher capital gains taxes for the rich.

Bloomberg News reported that Biden is planning a capital gains tax hike to as high as 43.4% for wealthy Americans.

The proposal would hike the capital gains rate to 39.6% for those earning $1 million or more, up from 20% currently, according to Bloomberg News, citing people familiar with the matter. Reuters and the New York Times later also reported similar stories.

Still, with Democrats’ narrow majority control in Congress, a tax bill like this could face challenges and many on Wall Street believe a less dramatic increase is more likely.

“We expect Congress will pass a scaled back version of this tax increase,” wrote Goldman Sachs economists in a note. “We expect Congress will settle on a more modest increase, potentially around 28%.”

Meanwhile, U.S. taxable domestic investors own only about 25% of the U.S. stock market, according to UBS. The rest of the market is owned in accounts that aren’t subject to capital gains taxes such as retirement accounts, endowments and foreign investors, so the impact on overall stock prices should be limited even with a higher tax rate.

“We would expect opportunistic investors who are unaffected by this proposal to step in and take advantage of lower prices,” UBS strategists said in a note Friday.

Intel shares dropped more than 5% after it issued second-quarter earnings guidance below analysts’ hopes. American Express fell over 4% after the credit card company reported quarterly revenue that was slightly short of forecasts. 

Snap shares, meanwhile, jumped 7.5% after the company said it saw accelerating revenue growth and strong user numbers during the first quarter. Snap broke even on the bottom line while posting revenue of $770 million.

Corporations have for the most part managed to beat Wall Street’s forecasts thus far into earnings season. Still, strong first-quarter results have been met with a more tepid response from investors, who have not, to date, snapped up shares of companies with some of the best results.

Strategists say already-high valuations and near-record-high levels on the S&P 500 and Dow have kept traders’ enthusiasm in check. But indexes are within 1% of their all-time highs.

Shivani Kumaresan, Shreyashi Sanyal and Herbert Lash of Reuters also report Wall Street rallies on strong economic data; tech in focus:

U.S. stocks rallied on Friday, driving the S&P 500  to a near-record closing high, after factory data and new home sales underscored a booming economy while megacap stocks rose in anticipation of strong earnings reports next week.

The bounceback follows a sell-off on Thursday when reports that U.S. President Joe Biden plans to almost double the capital gains tax spooked investors. Analysts dismissed the slide as a knee-jerk reaction and pointed to the strong outlook.

As the three major Wall Street indexes surged, the CBOE market volatility or "fear" index (VIX) plunged almost 10% in a sign of tumbling investor anxiety about the risks ahead.

Companies are providing guidance after staying quiet during the pandemic, while lower bond yields and results that beat estimates are driving the rally, said Tim Ghriskey, chief investment strategist at Inverness Counsel in New York.

"There is a lot of anticipation of what's to come," he said. "We've seen actual reports beating these very high expectations. Yields have come back down, which is very positive for tech."

Earnings take center stage next week when 40% of the S&P 500's market cap report on Tuesday through Thursday, including the tech and related heavyweights of Microsoft Corp (MSFT), Google parent Alphabet Inc (GOOGL), Apple Inc (AAPL) and Facebook Inc (FB).

Those names, including Inc (AMZN), supplied the biggest upside to a broad-based rally in which advancing shares easily outpaced decliners.

Expectations for company results have steadily gained in recent weeks as opposed to a typical decline as earnings season approaches. First-quarter earnings are expected to jump 33.9% from a year ago, the highest quarterly rate since the fourth quarter of 2010, according to IBES Refinitiv data.

U.S. factory activity powered ahead in early April. IHS Markit's flash U.S. manufacturing PMI increased to 60.6 in the first half of this month, the highest reading since the series started in May 2007. 

In another sign of strong consumer demand, sales of new U.S. single-family homes rebounded more than expected in March, likely boosted by an acute shortage of previously owned houses on the market. 

All the 11 major S&P 500 sectors were higher, with technology (XLK) and financials (XLF) leading gains.

Ron Temple, head of U.S. equity at Lazard Asset Management, said the U.S. economy is about to post the strongest growth in 50 years, with more than 6% gains both this year and next.

The Federal Reserve will allow the economy to run hotter than in the past, adding to the high-growth outlook.

"Investors are gradually coming around to the sheer magnitude of excess savings, pent-up demand and the implications of such a massive wave of fiscal stimulus," Temple said.

Stocks surged just before the bell, with the benchmark S&P 500 falling a bit to miss setting a record close.

The Dow Jones Industrial Average  rose 0.67% to 34,043.49 and the S&P 500 gained 1.09% at 4,180.17, just below its previous closing high of 4,185.47 on April 16. The Nasdaq Composite added 1.44% at 14,016.81.

For the week, the S&P 500 unofficially fell 0.13%, the Dow about 0.46% and the Nasdaq 0.25%.

Some earnings reports on Friday were lackluster, with American Express Co (AXP) sliding 1.9% after reporting a slump in credit spending and lower quarterly revenue.

Honeywell International (HON) fell 2.1% after missing revenue expectations in aerospace, its biggest business segment.

Naked Brand Group (NAKD) jumped 4.8% after shareholders approved the proposed divestiture of the company's Bendon brick-and-mortar operations.

Image sharing company Pinterest Inc (PINS) gained 4.2% as Credit Suisse raised its price target, saying newer product offerings and expanding footprint in markets abroad will yield higher revenue and user growth.

Advancing issues outnumbered declining ones on the NYSE by a 3.62-to-1 ratio; on Nasdaq, a 2.82-to-1 ratio favored advancers.

The S&P 500 posted 81 new 52-week highs and no new lows; the Nasdaq Composite recorded 111 new highs and 20 new lows.

Alright, it's Friday, another volatile week but we ended on a high note today as stocks rallied sharply.

When you look at the weekly charts of the S&P 500 ETF (SPY), it looks solid led by gains in Tech (QQQ) and Financials (XLF):

When you see stocks breaking out like this, making new record highs, two things are going on:

  1. The quant funds/ CTAs are all chasing momentum, buying every dip as long as it's above the 10-week moving average.
  2. Global macro funds are shorting this market as valuations are stretched and don't justify such a run-up in stocks.

The regular retail investor will likely stay invested as their financial adviser tells them "there may be a correction but stick with stocks," but as we approach May, I'm reminded of an old saying: "Sell in May and go away."

Still, this market keeps grinding higher as central bank liquidity keeps supporting risk assets.

But don't be fooled, there are signs of excesses and there are plenty of reasons to remain cautious.

The biggest tell-tale sign that we are reaching a top is that margin debt hit another record high in March to top $822 billion, according to FINRA data:

Investors are trading on margin like never before, despite the risks associated with the practice.

According to newly released data from FINRA, margin debt rose 71% year-over-year to hit a record $822 billion in March.

That's a 1.1% increase over February's previous record high of $813 billion.

Margin debt previously spiked to record highs before the dot-com bubble and in 2007 just three months before the 2008 financial crisis.

The chart below from Advisor Perspectives illustrates just how closely margin debt tracks with the S&P 500.

When The Wall Street Journal asked James Angel, a Georgetown University finance professor, about the trend of rising margin debt back in December of 2020 the professor said "the stock market is euphoric right now" and that "a lot of people are extrapolating from the recent past."

"We've seen this play out before, and it doesn't end well," Angel added.

On the other hand, in January, Bank of America told its clients that "investors are not over-levered in terms of margin debt as a percentage of the S&P 500 market cap, with room to run when compared to 2007 through 2018 peak levels."

Since January, margin debt has risen another 3%, but the pace of increase isn't as fast as it was in 2020.

Still, a number of experts have warned about the use of excessive margin debt, including Edward Yardeni, the president of the consulting firm Yardeni Research.

Yardeni told the Wall Street Journal that margin debt "fuels bull markets and it exacerbates bear markets and to a certain extent you put it on the list of irrational exuberance."

"The further that this stock market goes, the higher that margin debt will go, and when something blows up that will be one of the factors for why stocks are going down," Yardeni added.

Michael Burry also warned about record levels of margin debt in the financial system back in February before taking down his Twitter account.

"Speculative stock #bubbles ultimately see the gamblers take on too much debt," the investor tweeted along with a chart showing the S&P 500 and levels of margin debt both soaring in recent months.

We shouldn't be surprised that more investors are trading on margin.

First, more people are opening accounts to trade and most of them are (foolishly) using margin.

But that's the margin we see. What about all the swaps being used by "sophisticated" family offices like Archegos and elite hedge funds?

It's a game of positioning, they keep cranking up the leverage, knowing full well most funds are market weight or underweight, and it all works well until something blows up.

I keep coming back to small caps (IWM) that had a spectacular run over the last year but the rally is stalling here and the risks of a significant correction/ sell-off are high:

Small caps are very sensitive to the economy but elite hedge funds leveraged this trade up to wazoo and now they're priced for perfection and vulnerable as a reversal looks imminent.

I did notice biotechs (XBI) are bouncing here but they're in correction mode:

The same thing with solar (TAN), IPO (IPO) and Chinese internet stocks (KWEB), they bounced this week but are in correction mode:

Of course, this is what you'd expect as the excesses of last year are being wrung out of the market.

As long as Financials and Big Tech are fine, stocks can keep grinding higher but the truth is this market can turn on a dime.

Do you remember Quant Quake 2.0 that hit markets back in September 2019?

I'm worried something similar is going to happen, I just don't know when.

All I know is this isn't a time to play roulette with your retirement.

What else? All the inflationistas are huffing and puffing but PIMCO is right, it's a big head fake:

Over the next several months, we expect to witness a multi-month price level adjustment, which will feel a lot like a shift higher in inflation. However, over the second half of 2021 as the U.S. economy continues to normalize, we believe sequential (quarter-over-quarter) growth in real economic activity and prices will slow, bringing down the y/y rate of inflation. We expect core Consumer Price Index (CPI) inflation will end the year running modestly below 2%, and although core CPI is expected to accelerate to 2.2% in 2022, differences in index construction mean that the Fed’s preferred core personal consumption expenditures (PCE) price measure will lag. This disappointment might be all the markets need to moderate expectations for tighter Fed policy.

You should all read Brian Romanchuk's rant about base effects

What about Whirlpool raising prices on some appliances by as much as 12%?

So what? They're taking advantage of pent-up demand for appliances to gouge consumers but they're only shooting themselves in the foot and my prediction is the company will step back from these price increases in a few months, maybe sooner.

There's a lot of nonsense on inflation and even more nonsense on the imminent breakdown of the US dollar:

It's not breaking down, it will come roaring back as the US economy recovers, and when it does, it will mute any transient inflation pressures.

Anyway, read Francois Trahan's latest on whether we are at an inflection point for cyclicals here as he goes into the USD and inflation in more detail. 

Francois states that cyclicals have yet to price in the full lagged effects of the Fed rate cuts last year, I'm not convinced of this as the ferociousness of the rally in cyclicals and other stocks is unlike anything we have ever seen before. 

Also, I can't get Jeffrey Snider's discussion on the eurodollar futures contract leading the Fed off my mind: "This market anticipates what the Fed will do."

Below, MacroVoices Erik Townsend and Patrick Ceresna welcome Jeff Snider back to the show where Jeff makes the case for deflation rather than inflation, against consensus. You can download Jeff's charts here

And Marko Kolanovic, J.P. Morgan chief global markets strategist, says the best days of the reopening trade are still ahead. With CNBC's Melissa Lee and the Fast Money traders, Guy Adami, Tim Seymour, Karen Finerman and Bonawyn Eison. 

Lastly, David Giroux, portfolio manager of T. Rowe Price’s Capital Appreciation Fund, says they are underweight on equities because they've had trouble finding absolute value. He joins 'Closing Bell' to discuss. I agree with him, take the time to listen to his insights.