Wednesday, June 4, 2014

Sell in May and Go Away...Wrong

From the Desk of Joe Rollins

I would like to discuss why it would be a bad idea for you to sell now and go away for the rest of summer. The talk on Wall Street for many years is that most of the money is made in the period between October and the following May; the thought is that by avoiding the volatility and losses of the summer, you will actually end up much better than remaining invested June through September. I believe this year we might have an argument to stay fully invested for the summer, which I hope to explain later in this post.

If you followed the maxim of "sell in May and go away", you would have missed out on what ended up being quite a good month. For May, the Standard & Poor's 500 was up 2.3%, and up a total of 5.0% for the first five months of the year. While certainly not the fiery results of 2013, still quite good. The Dow Jones Industrial Average was up 1.1% for the month of May and sits nicely for the year, up 1.8% The NASDAQ Composite had an excellent month, up 3.2%, but has suffered more losses than the other major indices putting it at 2.0% for the year.

The Russell 2000 (small cap) index continues to struggle. While up 0.8% for the month of May, it is still down 2.0% for 2014. The Barclay's Aggregate Bond Index was up 1.1% for the month of May and sits even higher at 3.8% for all of 2014. All in all, May was a great month with all major indices and even bonds posting higher returns.

May was a very good month for the Rollins household as well - there was the always exciting end of the school year/beginning of summer, and both of my children celebrated their birthdays. Joshua turned 19 this May and his little sister Ava turned 3. Despite writing some of the most interesting and provocative posts known in the financial world, virtually the only blogs anyone ever comments on are the ones that include pictures of my children. In fact, I am often criticized because there is not a picture of them in every blog I write. So I thought I would briefly divert your attention from the financial news with these pictures (Josh & Ava attending a recent Braves game, another ball to add to Ava's collection, and me & Ava celebrating her BIG 3).

And now back to it...We continue to see high volatility in the underlying small-cap stocks, and to a lesser degree, the NASDAQ Composite stocks. Since the middle of March, these indexes have been punished pretty much on a daily basis. As I mentioned in my last posting, I do not believe for a second that there is anything underlying fundamentally negative about small cap or over-the-counter stocks. I think this all relates to a normal rotation with professional trades switching from one segment of the market to another.

Seemingly during this time frame, small cap stocks have suffered since there has been a rotation out of the smaller technology stocks and more importantly the biotechnology stocks into either bonds or large cap stocks. Given the potential for profits in these small cap stocks, I am a long way from wanting to give up our positions. I think we will ride them out for a few more months and see exactly what happens.

It is also interesting to note the economic news during the month. The original forecast of the GDP for the first quarter of 2014 came in at a 0.1% gain - that is about as close to breaking even as you can actually get. However, just last week they announced a slight revision of their GDP calculation to recast the first quarter GDP to -1.0% growth. It was astonishing to see the articles written by traditional newspapers regarding this negative GDP growth for the quarter. There were even publications that were thoroughly examining the definition of a recession and back-to-back negative GDP growth.

I wish people would exercise some common sense when it comes to basic economic reasoning. There is virtually no one skilled in the science of economics that believes the country is in a recession. In fact, most economists are calling for the GDP growth of close to 3.0% for all of 2014. I certainly see GDP growth in the quarter we are currently in at 2.5% at trending higher. For anyone to assert the U.S. economy is falling into recession clearly is not viewing the economic conditions correctly.

Actually, I would be somewhat shocked if the GDP for the second quarter of 2014 was not in the 2.5% range. It is inconceivable to me that with car sales up drastically, home construction on the upswing, and manufacturing operating at near full capacity, that we could not reach that 2.5% level. Additionally, consumer confidence and consumer spending continues trending higher, which could be a sign of an even higher GDP for the rest of the year. As any student of basic economics knows, if economic activity grows, clearly profits will rise, leading to higher financial markets.

As for the value of the market pricing today, it is fairly clear to me that with little moving in the market for 2014, the market is essentially priced the same as it was at the end of 2013, except now the earnings are higher. As I mentioned in my previous post, the three components - higher earnings, better economic activity and low interest rates - are all intact. Therefore, no change is warranted to our basic investment philosophy at this time.

When it comes to interest rates, if you have not refinanced your mortgage, you are missing out on a fabulous opportunity. Interest rates are currently at some of the lowest levels of all time. This may be the last time you can refinance at such low rates. Just in the last week, I have seen the ten-year treasury move from 2.4% to 2.6%. I think it is finally starting to loosen up and the bond market is realizing that economic activity is on the uptrend. While certainly higher interest rates do not look good for the bond market, they clearly support a higher stock market.

As we move forward into the summer, it would not surprise me to see the market move higher. Given the extreme volatility we have noticed in 2014, it would not even surprise me to see the market jump up 5% or 6% in one month alone. While withstanding all the negative publicity we are reading, I personally still think the trend in the markets bode well for a low double digit return for 2014.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins

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