Investment Insights

 — Steve Orr 

Relax

The calendar and thermometer tell us summer has arrived. Time for markets and us to relax.   Except Wall Street’s Wall of Worry continues to add bricks. Here are a few: the slowing economy, global tensions, hurricane forecast and worse, the non-stop politician invasions in our text feeds. Relax? No. Hide under the desk? Perhaps.

This coming Friday closes the books on a very nice May. Through last Friday, the S&P 500 had gained 5.5%, the small-cap S&P 600 4.3% and most of the rest of the world between 3% and 4%. First quarter earnings reports helped push stocks out of their April consolidation. NVIDIA led the parade, accounting for roughly 40% of the S&P 500’s 6% year-over-year earnings growth.

Like stocks, bond prices also rebounded from April’s showers, blooming lower yields. A big driver for both asset classes in the month was the flat consumer price index report. Inflation continues to hang around the mid-3% area. The 10-year Treasury fell just over three-tenths of a percent during the first two weeks, but tough talk from Fed members about keeping short-term rates at present levels caused bonds to give back about half their rally. Regardless, the Bloomberg Aggregate index of Treasurys, corporate bonds and mortgages rose 1.6% though last Friday’s close. That is the index’s best May since 2019’s 1.8% rise, and second highest in 10 years. So, is it time to buy bonds? Our periscopes are up, but indicators are not yet green.  

Go away?

Pre-computerized trading, an old saw went “Sell in May and go away.” The seasonal pattern saw traders leave New York for the summer. Liquidity dried up and stocks drifted or posted negative returns in the summer months. This pattern perhaps never went away, but computer trading strategies and global markets mean the pattern is either nearly dead or very muted today. Looking at summers in all years since 2012, the S&P 500 has risen a median 3%, finishing the period positive 10 out of 12 years.

Sell in May is also less noticeable in election years. Ned Davis Research reports that since 1950 in election years, the S&P 500 has risen 77.8% of the time from April 30 through Halloween. The index has risen seven of the eight times during the Sell in May summer when Democrats occupied the White House.

Still, after an 11% rise, one is tempted to sit out this summer and hide from the political ads. The S&P 500’s rebound from April’s consolidation appears low on fuel. Only 43% of the 500 names in the index are trading above their 50-day moving average. The percentage of names making new four-week lows is larger than new four-week highs. Last Thursday’s three-quarters of a percent drop in the index was an outside range day. An outside range day occurs when the open is above the prior day’s high and the close is below the prior day’s close. An outside range day can be a sign of a trend change, in this case a new correction starting. We doubt that and would point out that trading volume was declining into a holiday weekend.

June’s returns for stocks have been a mixed bag over the past decade. Six wins and four losses making the S&P 500’s average return a negative half percent. Election years are different. Since 1950, the Dow Industrials, S&P and NASDAQ all have had positive returns between 1% and 3%. Did the NVIDIA results pull some of June’s gains into May? We do not think so but would be happy to have history continue to rhyme for election year returns. History also suggests rallies last through the summer in election years. We understand the attraction of harvesting 11% returns and earning 5%-plus on cash until the election. Our indicators, built on steady earnings estimates and strong balance sheets, outweigh that emotional tug. 

Not so fast

Last Wednesday’s release of the Fed’s meeting minutes let more air out of the Rate Cut Crowd. Wall Street, and Chairman Powell, still want rate cuts sooner rather than later. An economy chugging along in second gear says the Fed needs to wait on rate cuts. FOMC members in recent speeches also say wait on rate cuts. Remember that Powell has the last say on what goes into the minutes. He can use the minutes to shape market opinion about future Fed action. So, for the minutes to say whether rate cuts are high enough to slow the economy and inflation data is disappointing tells you that at least some Committee members think rates should be higher.

Housing has been in a recession the past two years, thanks to the jump in mortgage rates. Manufacturing slowed over a year ago; now it is the consumer’s turn to rein in spending. First quarter earnings call for consumer staples and discretionary sectors consistently mentioned “less spending” and customers trading down or limiting purchases. Walmart, Target and several fast-food chains have announced price cuts or new lower-priced items over the past few weeks. We do think the economy downshifts from second gear to first in the coming months. Recession? No, but perhaps the mythical “soft landing” is in the cards. 

Modest proposals

In the spirit of thinking on the beach this summer, we would offer a couple of proposals. Want to drain reserves from the banking system and lower our debt burden? Have Congress amend §12 USC 355(a) to allow the Fed to assign securities to the Treasury. “Assignment” is a fancy word for making a gift. In the old days we could flip the bond or stock certificate over and fill out the stock power form printed on the back. That would assign the ownership to the buyer, similar to signing off on a car title transfer. Having the Fed regularly assigning Treasury bonds and mortgages over to the Treasury would drain excess reserves. It would also have the happy effect of calling those bonds out of circulation so that the taxpayers (us) do not have to pay the principal and interest. The Fed has about $4 trillion, give or take a few billion, to get back to pre-shutdown levels. Think in terms of a down payment on debt reduction and zero odds of happening.

Tired of all the money talk in college athletics? Let’s have the NFL hold an auction for college teams, facilities and mascot every few years. Each NFL team bids on two university teams. Limit the auction to the largest 64 university programs. The NFL gets the name, mascot, access to stadium and facilities. The university gets cashflow, visibility and no NCAA, at least for football. Students can go to games and then study without worrying whether their star linebacker will transfer for more NIL money. The remaining 60 or so NCAA teams can stay in a revised NCAA FCS system. Players are NFL employees and can go between the XFL, practice squads and legacy university teams. Instant minor leagues and also a zero probability of happening.