So much for forecasting in my last minute thoughts. One European country after another has missed their austerity targets. This is nothing new and has been a chronic problem from the start of the crisis. It just keeps continuing. In case anyone has forgotten….the requirements for countries such as Spain, Portugal, France and Italy is not to actually reduce their debt, but only to reduce their deficit. In other words, it is expected that their debt will continue to rise, despite their austerity programs.
I have written about the phenomenon of bad European projections in the past – many times. In Business School we were taught to make conservative projections, as there were always unaccounted for events that would affect your financials. It seems that the European bureaucrats did not learn this lesson. They make projections that cannot possibly come true in a shrinking global economy, knowing full well that they will have to make adjustments in the future. But that is a problem for the future, not today.
Countries are starting to push back on their austerity requirements and ask for more time to meet their “goals.” The EU is in a bind. They can play “tough guy” with small countries such as Greece or Cyprus, but it gets hard to push big countries around, such as France. They are not going to push France out of the EU for failing to meet its targets, the consequences would be too severe, and really, what would be left of the EU. When France recently asked for a one year extension on their targets, the EU gave them two years. Maybe the thinking was that France would not meet their target in one year so it would be best to delay it for two years. My guess is that France will not meet their target in two years. At some point they are going to start making the targets so easy that they will be impossible to miss, just not yet.
This will not be the last time that European countries ask for an extension, nor will it be the last time that they will receive one. In fact, this will continue until the Germans can no longer take “giving” their money away. Merkel’s popularity is decreasing and it is going to be interesting to see how German support for Europe plays out around the German elections in autumn.
The battle between Germany and European countries “in need” is starting to heat up again. Germany is staunchly for austerity and does not understand why countries cannot bring their deficits under control. On the other side of the argument are the countries that have suffered under austerity and have seen little progress. For these countries austerity does not seem to be worth the pain. They are moving to a Paul Krugman (an American economics professor who has the ear of the Democratic party) approach of increasing government spending in order to grow your way out of the problem.
Expect more arguments along these lines as impatience with austerity grows…. “Europe’s move to give France two more years to cut its public deficit to below 3 percent marks the end of the “austerity dogma” in Europe, French Finance Minister Pierre Moscovici said” (Reuters May 5th).
Remember last July 26th when Draghi said that the ECB is ready to do whatever it takes to save the euro. It helped to drive the markets higher and everyone loved Draghi, as least for a while. Now that we have had a European rate cut to 0.5% and extension of liquidity out until 2014, it will not take long before Draghi starts to articulate plans for a negative interest rate for bank deposits with the ECB. If the stock market takes a summer swoon, investors should expect more chatter on this subject. A few months ago I wrote about the possibility of a currency war. Shortly after the release of that newsletter, the G7 publicly stated that they were all going to make sure that a currency fight would not take place. Not that anyone should believe them. Since Japan embarked on its money printing policy in order to “raise the inflation rate” the Japanese yen has depreciated substantially. From November 2012 the yen has depreciated over 30 percent relative to the USD and has just recently moved below “par” (100). It is actually quite comical when Japan states that there policy is domestic and has nothing to do with lowering its exchange rate. Really, come on…..who are you fooling.
According to the Financial Times on May 11, the “Finance ministers and central bank governors of the Group of Seven rich economies have reaffirmed a commitment not to seek to depreciate their currencies for domestic gain. After an informal two-day gathering in a country house hotel outside London with no communiqué, participants said on Saturday they were reassured by Japan that its revolutionary new economic strategy was not intended to weaken the yen.”
It keeps getting more ridiculous…..revolutionary new economic strategy. I don’t think so; there is nothing new about quantitative easing. I will give Japan credit for the scope of their quantitative easing is new (and foolish). Still from the Financial Times, “While taking a close interest in Japan, the G7 participants agreed that all members were sticking to their commitment struck in February to keep economic policy, “oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates”.
All that this says is that the G7 countries can pursue money printing policies, but they can only state that they are trying to boost their inflation rates and not targeting lower exchange rates. Worldwide inflation rates have been declining. According the JP Morgan International index, the global inflation rate was 4.5% in 2011 and as of February this year it had dropped to 2.5%. Okay….the doors are open for countries to print money in order to debase their currencies. So far, Japan is in the lead. Europe is attempting to catch up as it recently lowered its interest rate to 0.5% and increased liquidity into 2014. The extra stimulus in Europe is helping to boost their stock markets, which is also transferring some of its euphoria over to the U.S. and creating frothy market action.
As we enter the unfavourable season for the stock markets, I cannot tell if the market is going to peak in May as it often does, or continue to run for a while. In the 1990’s when technology stocks were the “only way to go” the market sometimes ran into mid-July. What I do know is that it makes sense from a seasonal perspective to reduce risk in portfolios at this time, which includes raising cash, reducing beta and re-investing into seasonally strong sectors. Although there is still upside potential in the market, the risk-reward relationship at this time favours a conservative stance in the markets.
The Costco seasonal trade is a new addition in my Investor Guide series books. Although Costco is a retailer it is classified as a consumer staples company because of the nature of the products that it sells. It is a valuable seasonal trade because its seasonal period of strength starts in late May where there tends to be a dearth of companies starting their seasonal trends.
On March 12th Costco released strong earnings which helped the stock outperform the S&P 500 briefly. The stock has recently been performing “at market.” and is at the top of its trading channel. The ideal situation would be for price action to reach the bottom of the price channel at the start of the seasonal period. Investors should be looking to add Costco towards the end of this month, or if it corrects back down to the bottom of its recent trend channel and the full stochastic oscillator bottoms and turns back above 20.
At the time I was writing the April newsletter it looked like 3M was going to put in a positive performance during its seasonal period, but underperform the market. With a rocketing performance in the last few days of its seasonal time period, it was able to slightly outperform the S&P 500. The seasonal period for 3M has finished and investors should consider exiting the position.
Although I did not write about the Dupont trade very much in the last few months, Dupont has a strong seasonal period from January 28th to May 5th. Judging by the feedback I have received, it seems that a lot of investors have taken advantage of the seasonal trade. This year, it started off as a market perform trade, rising with the market. In late April, Dupont came out with very strong earnings that beat analyst estimates and the stock rocketed upwards, strongly outperforming the S&P 500. From a seasonal basis, on average Dupont starts to underperform the stock market once it ends its seasonal period (May 5th). This downward trend persists until the end of the year. Investors should consider taking profits at this time.
I have always advocated using the consumer switch strategy – investing in the consumer staples strategy from April 23rd to October 27th and switching to the consumer discretionary sector for the other part of the year. The strategy has been very successful, including this year with the consumer discretionary sector outperforming the consumer staples from October 28th to April 22nd. I often choose the consumer staples sector as a top pick for the summer months. This year, is no different. Despite the strong outperformance of the consumer staples sector in the spring months the consumer staples sector is still a core holding for the summer months. Investors should expect that this sector will underperform when the market is rising on the back of cyclicals and outperform when cyclicals are underperforming. Yes, the consumer staples sector is trading at a 17.7 forward P/E multiple, which is expensive for the sector, but over the next six months it is still a favoured sector.
The biotech sector starts its seasonal trend on June 23rd and lasts until September 13th. The performance of biotech stocks is driven partly by conferences which tends to bring interest to the sector. With autumn being a busy time for biotech conferences, investors can drive the price of biotech stocks up in the late summer months. Typically, the biotechnology sector performs poorly in the spring months, but this year the sector started to perform well at the beginning of March. More recently, it has been performing at market.
At this point it is best to wait for the start of the seasonal trade on June 23rd before entering a position.
A lot of writers have discussed how the days around American holidays tend to be positive, including Memorial Day. The basic premise behind this trade is that institutional trader activity subsides significantly around the holidays and the optimistic, retail investors have more sway over the markets and push the markets higher. This includes the days before and after Memorial Day. I have stretched the Memorial Day Strategy Trade out to include the first five days of June. The reason is that typically the best time of the month to invest in the stock market is the last few days of the month and the first few days of the next month. I have developed a strategy that encompasses this phenomenon, called the Super Seven. As Memorial Day occurs towards the end of the month, it makes sense to put the two typically positive seasonal trends together.
There are two ways to take advantage of the Memorial Day seasonality. First, investing in a S&P 500 ETF for the full period from two trading days before Memorial Day to five trading days into June. Second, for Canadians only, investing in a TSX Composite ETF at the end of the day before Memorial Day and selling it at the end of Memorial Day when the U.S. markets are closed. The performance of Canadian markets during American holidays tends to be strong. As a result, I have developed a strategy called “Canadians Give Three Cheers for American Holidays” . Of course both strategies can be used.
How successful are the strategies? Since 1971 (in 1971 Congress passed the National Holiday Act, recognizing Memorial Day as the last Monday in May), the Memorial Day strategy has been successful 64% of the time, producing an average 1.1% gain. During this period, there have been some large gains and some large losses. Most recently, over the last ten years the strategy has only been successful four times, but the overall gains outweighed the losses. It seems that if the first part of May is weak, the sentiment can carry over at the end of the month. This has been the case in the last two years. So far the S&P 500 has been strong at the beginning of May. A correction into the start of the Memorial Day strategy would set up the trade nicely.
Using the “Canadians Give Three Cheers for American Holidays”. the memorial day strategy has been very successful. Since 1977 the success rate has been 80%, with an average gain of 0.4%. The seven drawdowns have all been much smaller than the average gain, making this an excellent short-term trade.
Although the broad market is on average weak during the six month unfavourable period, there are pockets of outperformance. The Memorial Day strategy trade is one of the trades that investors should look to garner some extra profits during the summer months.
Government bonds typically perform well from May 6th to October 3rd, in both Canada and the U.S., with the real sweet spot of the trade occurring in August and September. Using the Barclays 7-10 U.S. Government Bond Total Return Index, the trade has produced an average gain of 4.8% and has been positive 77% of the time. The sector can get an early start when equity markets are in trouble, and it often starts its rise two weeks after the market tops. Government bond sector outperformance during its seasonally strong period makes sense from a market rotation perspective. When the stock market fades as it often does in the late spring, investors use their proceeds to buy bonds. In autumn, as the stock market tends to rise, investors sell their government bonds to invest in stocks.
Currently, the government bonds market is off to a rocky start as cyclical stocks have put in a brief spat of strong performance and there is some discussion of how and when the Fed is going to reduce their current quantitative easing program. On May 11th, Wall Street Journal’s Jon Hilsenrath published a much anticipated possible framework on how the Fed might start to reduce its bond buying. Somehow it seems that Hilsenrath has inside information on the Fed’s plans, as his predictions often come to fruition.
Even so, the framework that Hilsenrath presents does not include any time lines. The recent discussion of the Fed possibly buying fewer bonds has hurt the bond market.
Nevertheless, given the current weakening economic climate, it is going to be difficult for the Fed to take its foot off the gas pedal. Also, with Japan and Europe increasing liquidity into their markets, if the Fed starts to take the opposite tact, then the USD will strengthen, which will in turn decrease their exports and increase their trade deficit and ultimately hurt the American economy. It is going to be difficult for the Fed to start withdrawing liquidity.
Overall, despite their low yield, government bonds are still a favourable seasonal investment. If poor economic numbers continue to be released, investors will once again be attracted to the bonds. Yes, the April non-farm payroll employment number was favourable, but recently, most economic reports from around the world have been less than favourable. If we continue to have falling inflation, falling PMIs, falling GDP growth, the discussion will once again return to deflationary expectations.
From a technical perspective, government bond sector, represented by the iShares 7-10 year Treasury Bond ETF (IEF), has a downside target of 105 which is the bottom of the trading range over the last year. Recently, IEF broke above its trading channel, but then corrected sharply back to 107.33, which is just below its 50 day moving average. It is possible that there is some short-term weakness ahead, but overall over the next five months the trade is expected to be favourable.