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Stuck In The Middle As Seasonal Sell Signals Trigger

By Lance RobertsETFsMay 17, 2020 01:18AM ET
www.investing.com/analysis/stuck-in-the-middle-as-seasonal-sell-signals-trigger-051620-200524845
Stuck In The Middle As Seasonal Sell Signals Trigger
By Lance Roberts   |  May 17, 2020 01:18AM ET
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Currently, we seem to be stuck in the middle even as seasonal sell signals trigger. It reminds me of the lyrics of one of the classics.

“Trying to make some sense of it all,
But I can see that it makes no sense at all,
Is it cool to go to sleep on the floor,
‘Cause I don’t think that I can take any more
Clowns to the left of me, jokers to the right,
Here I am, stuck in the middle with you” – Stealers Wheel

It’s a fascinating dichotomy in the markets currently. As noted last week:

“There is currently a “Great Divide” happening between the near “depressionary” economy versus a surging bull market in equities. Given the relationship between the two, they both can’t be right.”

This past week, the continuation of depressionary economic data continued:

These are numbers not seen since the Great Depression, with expectations for economic growth in the second quarter at a -31.5% growth rate (shown below). The Atlanta Fed GDP Now is even worse with a -42.8% decline in GDP growth in the second quarter.

GDP Estimates
GDP Estimates

These numbers are mentally hard to grasp. Yet, the markets remain range-bound between the 50% and 61.8% retracement levels, consolidating the advance from the March 23rd lows.

SP500-ETF Daily Chart
SP500-ETF Daily Chart

The reason for the dichotomy is simple.

Fed Balance Sheet
Fed Balance Sheet

The bullish argument for stocks remains simple. As long as the Federal Reserve is pumping in liquidity, buy stocks.

Earnings Continue To Decline

As investors, however, we need to be paying attention to earnings. There is a simplistic correlation between the economy and the markets. As I questioned in The Stock Market Is Not The Economy?

“The relationship becomes more evident when looking at the annual change in stock prices relative to the yearly change in GDP.”

GDP Vs S&P Stock Prices Annual Change Stock Prices
GDP Vs S&P Stock Prices Annual Change Stock Prices

“Again, since stock prices are driven in part by the ‘psychology’ of market participants, there can be periods where markets become detached from fundamentals. However, there is no point in previous history, where the fundamentals catch up with stock prices.”

S&P 500 EPS Annual Price Vs EPS Growth
S&P 500 EPS Annual Price Vs EPS Growth

As stated, the equation is simplistic:

“Slower economic growth = less consumption (due to unemployment) = lower profit and revenue growth.”

Based on the current economic devastation, earnings estimates for the next couple of quarters have fallen sharply. Unfortunately, they still have not compensated for the coming drop in revenues.

SP500 Earnings Estimates
SP500 Earnings Estimates

It’s The Economy Stupid

How do I know that?

“PCE depends on jobs and wages as well as an intact supply chain, neither of which are in good condition. Regarding unemployment, the U6 rate, which is a more reliable indicator of job market health, is at 22.8% currently and rising while the labor market participation rate has dropped to about 60%. These factors do not bode well for growth and earnings for most companies.” – A Brinkley, Jr.

His statement is correct. There is a precise correlation between PCE and GDP. Not surprisingly, if consumption contracts due to high levels of unemployment, then economic growth declines. (PCE is 70% of GDP)

PCE Drives GDP
PCE Drives GDP

The other problem is investors remain overly optimistic about the recovery prospects for earnings going into 2021. As shown, in April 2019, it was estimated the S&P 500 would earn $174/share (reported earnings) at the end of 2020. Today, estimates for Q4-2021 now reside at just $147/share. This is a 15% contraction in estimates when we are discussing a 30-40% decline in GDP.

SP500-Estimates 2021
SP500-Estimates 2021

Valuations Matter

With expectations for the S&P 500 to return to all-time highs in 2021, such would mean that valuations currently paid by investors remain at historically high levels.

SP500 PE Fwd Estimates
SP500 PE Fwd Estimates

As Warren Buffett states: “Price is what you pay, value is what you get.”

While it seems these concerns are irrelevant due to the Federal Reserve’s ongoing liquidity injections, fundamentals and valuations always matter over time.

3-Different Bulls

We have talked before about the “narrowness” of the market. Since the March 23rd lows, the “bull market” advance was three different “bull markets.” The three charts below break out the sectors of the market down into “bull market” groupings. I have recalibrated each sector to a $50 starting price in January of this year.

The “Struggling Bull” market has been in sectors that we currently maintain no exposure to in portfolios. These are the sectors most exposed to either the “Coronavirus” impact, or the Fed’s monetary liquidity and zero interest rates.

Struggling Bull
Struggling Bull

Industrial and Transportation stocks are most affected by the economic shutdown, while Financial are impacted by reductions of net interest income from zero interest rates, and rising delinquency rates. All three sectors remain below $40, and only marginally above the March 23rd lows.

The next group we classify as a “Stuttering Bull” as the recovery has been better, but the sectors continue to underperform overall. These sectors have been primarily range-bound between $40 and $45/share since coming off their $30 lows.

Stuttering Bull
Stuttering Bull

These sectors—Utilities, Real Estate, Materials, Consumer Discretionary—are still susceptible to the impacts of the “economic shutdown” from reduced revenues, bankruptcies, unemployment risks, etc.

The last grouping are the sectors we remain most heavily weighted in. These are the companies that are “deemed” to be the most protected from the impacts of the “economic shutdown.” These sectors did not decline as much as the others during the selloff, and now all trade above $45/share.

Raging Bull
Raging Bull

These sectors—Technology, Communication Services, Healthcare, Consumer Staples—are in a “Raging Bull” market and are within striking distance of all-time highs.

This data tells us two important things.

  1. If you wanted to beat the S&P 500 this year, you needed only to own 4-market sectors, and;
  2. While earnings may not seem to matter at the moment, they eventually will. Staples, Technology, Communications, and Healthcare are all trading at very elevated valuations.

Most importantly, while the advance has been notable, participation has not only remained weak but continues to weaken during this consolidation.

SP500-Daily Chart
SP500-Daily Chart

With the MACD “seasonal sell” triggered, it may be time to turn a bit more cautious for the summer.

Seasonal Sell Signals Trigger

As I've discussed, the “Sell In May” strategy might be worth paying attention to this year. To wit:

“While not every ‘summer period’ is negative, the long-term history of investing during the summer months is not stellar.”

Growth Of $10,000 - Sell-In-May
Growth Of $10,000 - Sell-In-May

“However, the adage ‘Sell in May’ may be more appropriate this year given the state of the actual economy, earnings risk, and a potential revaluation of markets. The odds of a weak summer period have risen markedly.”

With the “seasonal sell” signal now firmly entrenched, the markets overbought on many levels, and participation remaining weak, the “risk” of having aggressive equity exposures has risen.

While the market can undoubtedly resolve stretched conditions by grinding sideways, such won’t fix the issues of participation and momentum.

SPX Daily Chart
SPX Daily Chart

Positioning Update

With seasonal sell signals in place, we are very focused on our positioning. While we did modestly increase our equity exposure during last week’s pullback, we did so in areas which remain defensive. We also balanced that increase in exposure with matched weights in shorter-duration Treasury bonds to hedge our risk.

Taking profits in our trading positions continues to be a “staple” in our management process. Such is particularly the case in positions like Clorox (NYSE:CLX), which have become grossly extended. Importantly, as noted in the sector performance analysis above, we also continue to rebalance portfolios into outperforming areas of the market.

The process is simple. As we continue to adjust our equity exposures to participate with the markets, we are balancing those increases with offsetting hedges, and a larger than average level of cash, to protect against sudden declines.

As I concluded last week:

“There is only one thing I am sure of, a raging bull market in stocks can NOT co-exist with a depressionary economy for long. The stock market is NOT the economy. But the economy is a reflection of the very thing that supports higher asset prices – corporate profits.”

We don’t like the risk/reward of the market currently, and suspect we will have a better opportunity to increase equity risk later this summer.

But, if things change, we will also.

Stuck In The Middle As Seasonal Sell Signals Trigger
 

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Stuck In The Middle As Seasonal Sell Signals Trigger

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Comments (9)
Stefano Scardia
Stefano Scardia May 18, 2020 7:33AM ET
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This market is a ticking bomb
Kevin Wickins
Kevin Wickins May 17, 2020 6:06PM ET
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As always your articles have a very reasoned approach  and ax pleasure to read.
Dizzle TheRizzle
Dizzle TheRizzle May 17, 2020 3:03PM ET
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Great info and great way of showing us what the underlying cause and effect are
Milos Bajsanski
Milos Bajsanski May 17, 2020 1:08PM ET
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Excellent, thank you.
William WANDD
William WANDD May 17, 2020 10:46AM ET
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Thumbs up for the article, and thank you for the analysis!
Robert Flores
Robert Flores May 17, 2020 10:03AM ET
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Its only a hand full of stocks outweighing/supporting this rally
Steve Wulfeck
Steve Wulfeck May 17, 2020 9:14AM ET
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Great article!
Klaus Weyers
Klaus Weyers May 17, 2020 5:33AM ET
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i am short equities.. target 2200 in s&p
jonathan seagull
jonathan seagull May 17, 2020 5:22AM ET
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This gives a very well positioned psychology.
 
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