Tuesday, June 6, 2017

Sell in May and Go Away - but where are you going to go?

From the Desk of Joe Rollins

Josh and Ava

Reid and Caroline,
Children of Robby Schultz, Partner of Rollins Financial,
and Danielle Van Lear, Partner of Rollins & Van Lear.

The saying above has been around since I started reading the Wall Street Journal in the 1970s. The presumption was that the best traders on Wall Street would sell in May and go to their Hampton resorts and sit out on trading for the summer. They would come back after Labor Day and get reinvested going into the end of the year. There were many that argued that the best months in the stock market were always November through May because this was when the active traders on Wall Street were around to cut deals in back rooms and invest in stocks.

Those days are long gone. Now, momentum trading occurs daily. Millions, if not billions, of shares are traded by machines that exploit pricing errors on stocks, and are thankful for a gain of a cent or two. In fact, the vast majority of all shares traded on all major exchanges are done by momentum traders, not human traders. I do not say that with criticism of these investors as I have studied and read books on the subject, and I can find no real harm that they cause. In fact, they even may provide a service. They move markets and stocks when there isn’t enough volume to do so. One thing is crystal clear. The old days of stock traders cutting deals in the back room to exploit the market for their own benefit and against small investors like you are as dead as the old proverbial buggy whip. That is a very good thing.

Once again, I have to report that the month of May was an extraordinarily good month for investing. The Standard and Poor’s Index of 500 stocks was up 1.4% for the month of May and up 8.7% for the five months ended May 2017. It is also up 17% for the one year period ended May 31, 2017. The NASDAQ Composite was up a banner 2.6% for May and is up 15.7% year-to-date. For the one year period, it is up a sterling 26.7%. The Dow Jones Industrial Average was up a meager 0.7% for the month of May, 7.5% year-to date and up a very strong 21.2% for the one year period then ended. Just for purposes of comparison, the Barclay’s Aggregate Bond Index was up 0.7% for the month of May, 2.2% for the year-to-date and 1.4% for the one year period ended May 31, 2017.

To answer the title of this blog, I thought I would go through a few asset classes to see if I could solve the age-old question, “If you sold in May, where would you go?” What is interesting now is that the economy is starting to pick up and the anticipation of lower tax rates, capital improvements to our roads and bridges and the expatriation tax are all fueling the market higher, contradicting the so-called “experts” that you see daily on the financial news.

Let us briefly look at the other asset classes:

1. Cash – Over the last several months as bond rates have increased, the earnings that money market cash accounts earn has gone up. About this time last year, cash was earning virtually zero, but now it is up 0.8% annualized and roaring ahead to a 1% annualized yield. Just for comparison, I would point out that the S&P 500 Index made 1.4% for the month of May, nearly twice the current rate of cash on an annualized basis. However, most people that are holding large cash balances are not doing so in money market accounts. They do so in non-income producing checking accounts under the misguided presumption that you need an emergency fund. That may have been true in the days before lines of credit on your house, credit cards and other investment accounts were around to provide a safety blanket. Holding cash in a non-interest-bearing money market account at the current time has no economic benefit.

2. Residential Real Estate – I am always baffled by people who obtain wealth suddenly want to own real estate. It could be for a number of reasons for their wealth such as inheritance, sale of business, life insurance or other new-found wealth. The one thing they almost always purchase is more residential real estate. I never understood why a couple would need a 10,000 square-foot house in the $5 million range. First off, someone would have to clean that house, which would be expensive. Second, the number of people that can actually afford that house is virtually nil. However, that is the first thing that wealth seems to want. It actually goes back as far as Gerald O’Hara’s famous quote to Scarlett in Gone with the Wind, “Why, land is the only thing in the world worth working for, worth fighting for, worth dying for, because it’s the only thing that lasts.”

In any case, residential real estate is currently borderline bubble territory. There is very little available residential real estate to purchase, and what is available to purchase is extraordinarily high-priced. As with every residential real estate boom and bust that I have seen, just as prices reach high levels, contractors flood in to build homes to satisfy this desire. In my 40 years of living in Atlanta, I have seen many residential real estate booms and busts. Almost invariably at these levels, you see the supply of houses increase and the value of houses decrease. The law of supply and demand. I am not suggesting that it would happen overnight, or even in the next few years. But I do know when the price of houses gets so expensive that the average homebuyer cannot afford to purchase, you are at the very top of the market and there is likely to be a downward trend for years to come. So, we are today.

3. Bonds – Every day I talk to clients about investments and bonds. You will find countless textbooks that say you should be invested in bonds based on some hypothetical age – however, I beg to differ. The Federal Reserve has already announced that there will be at least three interest rate increases during 2017. Currently, interest rates continue to be at all-time lows with a current 10-year Treasury note at 2.16%. But we also know that the labor market is outstanding, the economy is growing significantly and that the Federal Reserve is moving interest rates higher. At the current time, the position in bonds is more likely than not to produce a negative or marginal rate of return in the upcoming year, as it has over the last one-year period.

4. Commercial Real Estate – Of all the asset classifications in the real estate arena, commercial (non-residential) real estate probably has the greatest potential. Rents are just now beginning to catch up with the economy and are likely to increase. Since the average investor cannot invest in commercial real estate except through other entities, I will not bother to discuss these in greater detail.

5. REITs, Hedge Funds and Oil Pipeline ETFs – REITs have had an incredible run over the last year, but that has ended. With rising interest rates and the beating that retail shopping centers are currently taking, it is not likely that REITs will have much of a return going forward. Hedge funds, by all standards, have been a tremendous bust. Even though I review the reported results of hedge funds on a daily basis, most do not even come close to the financial returns of the S&P 500. In my opinion, the oil industry is going to be slow-growing for years to come. The advancement of technology in oil has revolutionized the industry, and going forward, the demand for oil will be well below the supply produced by the companies that frack oil in America. There is a great amount being done with Hybrid cars. Increased mileage and no need for oil coupled with the oversupply of oil around the world, I suspect to see oil prices depressed at this level for at least a decade. I am not surprised at all that some of our friends in the Middle East are suffering from an economic meltdown. We knew it was going to happen at some point, but no one expected it would last this long. And now they too are suddenly cutting corners and pinching pennies. It could not have happened to a nicer group of investors.

As for the stock market moving forward, there is excellent potential. As the first quarter comes to an end, earnings for the first quarter on the S&P 500 were 14% higher than the same quarter last year. The much-respected Federal Reserve Bank of Atlanta is now predicting the GDP growth in the second quarter will be 3.4%. Didn’t I just hear on T.V. last week from almost a consensus of democratic congressmen that 3% growth was unattainable?

The unemployment report from last Friday was nothing short of spectacular. With an unemployment rate of 4.3%, almost all of America is now fully employed and when you have employment, you have consumer spending. Basically, the U.S. economy is at full-employment and throughout the U.S., employers are reporting the lack of qualified employees to fill positions. Of course, there are isolated pockets of unemployment, but in the good manufacturing markets, unemployment is down close to 3.5%. Something is going on in manufacturing that no one has forecasted and can only be good for the stock market.

You may remember that many forecasters said that Hillary Clinton was a “slam dunk” to win the election. I might have even said that myself. One of the things that they all agreed upon was that you could not stop illegal immigration in the United States. I guess the news that illegal immigration has slowed to a trickle into this country would be surprising. It is interesting to me that it was not necessary to build a wall, but to simply enforce the laws that currently exist.

The rest of the world is rushing to manufacture in the United States. There is a simple reason that the current administration continues to enforce fair trade rather than open trade. Over the next ten years, we will see an explosion of foreign manufacturers in the United States in order to avoid tariffs, making the manufacturing outside of the United States unprofitable. This is a great thing for the U.S. and for U.S. employment.

Therefore, the three important components of higher stock prices are clearly and unmistakably in place. Interest rates continue to be extraordinarily low and earnings appear to be excellent and getting much better. Most importantly, the economy is strong and getting stronger. Therefore, the trifecta of economic importance of higher earnings is firmly in place, and I expect the market to trend higher going to the end of the year.

Every day I meet with potential investors who state that they do not want to experience another year like 2008. Believe me; I would not want that either. However, if you look back at the economy in 2008, which was experiencing a financial meltdown, as compared to the economy today, how could you even contemplate that the stock market would perform at the same levels? Back then, the economy was fragile and breaking; today, it is strong and soaring. There is zero comparison between 2008 and 2017.

This morning, I heard someone on T.V. exclaim that it would be hard for the market to rise since there is such a high percentage of financial resources allocated to stocks. Actually, the exact opposite is true. In 1998, 60% of adults in the U.S. were invested in the stock market. In 2008, 65% of those adults were invested. Yet today, less than 54% of the U.S. population is invested in stocks. There is an avalanche of money, cash and resources that will come into this market over the next few years. This will create a backstop for any swift decline. While you will certainly see swings up and down as we move forward, I fully anticipate that over the next year markets will be higher than they are today. The one thing I am confident about is that if you have a 20-year period before you actually need the money, the markets will be significantly higher than they are today.

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

Best Regards,
Joe Rollins

No comments: