The biotech sector starts its seasonal trend on June 23^rd 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.

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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.

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Government bonds typically perform well from May 6^th 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.

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As mentioned last month, HAC entered into a long CAD trade in mid-March. The technicals supported an early entry into this trade. Typically, the Canadian dollar performs well in April. For the first part of April, the Canadian dollar corrected relative to the USD. In the second half of the month, the CAD soared as the USD fell and commodities rose. In the end, the trade was once again successful. More recently, the USD has once again been garnering strength, pushing the Canadian dollar down. If seasonal investors are not already out of this trade….they should be.

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The energy sector trade ended on May 9th. Over the last three years this seasonal trade has struggled, including this year. In my earlier newsletters, I pointed investors to invest in the U.S. energy sector as it was a better opportunity than Canada. The trade typically starts on February 25th, but this year it started earlier in January. At the beginning of its seasonal period, the technicals looked good for the Energy Select Sector SPDR (XLE), but the sector soon after faltered. Overall, the trade produced a positive result in the U.S., but underperformed the S&P 500. Not good enough. In Canada, using the S&P/TSX Capped Energy Index Fund (XEG) produced a loss.

HAC started investing in the energy sector in January, concentrating on U.S. holdings. The sector started to underperform the S&P 500 when it should have been outperforming. As a result, HAC started to exit the sector well before the seasonal end date. The good news is that HAC rolled the proceeds back into S&P 500 ETFs to participate the rising broad market.

The energy sector showed fairly strong performance towards the end of its seasonal period in late April and the beginning of May, but as it has not shown steady outperformance relative to the S&P 500, and the seasonal period has ended, the best strategy for seasonal investors at this time is to exit the sector. The energy sector has another seasonal period in late July, warranting an early entry in late June if the technicals support an early entry. It is best to revisit this sector at that time.

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Over the last few months I have been writing about the seasonal and technical picture of gold bullion, even though we are not in the seasonal period for gold. There seems to be so much interest in the subject, how could I not address the topic? To continue where I left off last month… gold was sitting on the $1550 support line at the time. Given that we were not in a strong seasonal period for gold, there was significant risk on the downside if the $1550 line was broken. Shortly after the release of my newsletter, there were whiffs of deflation as PMIs around the world seemed to be falling below expectations. At that time, Goldman Sachs came out with a recommendation to sell gold short. There was no question that gold was vulnerable to a correction – and correct it did.

So where are we now….still outside of the seasonally strong period for gold. Gold bullion’s seasonal period is from July 12th to October 9th. Given that an investment can be made in this sector on a seasonal basis a month early, based upon strong technicals, it is best to let gold bounce around for the next month. At this point, gold could increase or decrease. It is best to wait until there is a seasonal tailwind to help push the price of gold up. Next month the conversation will be much more interesting.

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HAC Strategy – Since the beginning of the year HAC has been rotating out of the sectors of the market and favouring an investment into the S&P 500 ETFs. It is not that we wanted to be invested in the broad market at this time, as we would rather be invested into outperforming sectors, but with some of the typically seasonally strong cyclical sectors underperforming, a safer play was to capture the broad market gains. Readers of this website can see an increasing position in S&P 500 investments from January to April. In the unfavourable season (which we have just started) HAC will endeavour to take advantage of seasonal opportunities in both sectors and the broad market. As the seasonal opportunities come to an end, HAC will typically rotate back into a cash position. As more seasonal opportunities present themselves, HAC will once again rotate into those positions. Over the last few years, this strategy has served HAC well. It is important to note, that at the end of April, HAC was substantially in cash.

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May 5th has arrived and the unfavourable season for stocks has started. May 5th as an ending date for the favourable period might seem different as almost everyone else uses April 30th. Why May 5th? I found in the past that on average May 5th was a far superior exit date for the favourable period for stocks, compared with April 30th. The reason: the first few days of most months tends to have a strong positive bias, including May. In fact, I developed a strategy where I illustrated that from 1950 to 2010, the first three trading days produced an average gain of 0.5% and have been positive 69% of the time. There is no denying that these are very strong figures.

S&P 500 Technical Status

Last month the S&P 500 maintained its uptrend, despite some volatility mid-month. My breakdown point for the S&P 500, 1525 was not reached and the S&P 500 maintained its technical integrity. Yes, it did break its uptrend line,
but this is warning, not a breakdown. It also bounced of its 50 day moving average and proceeded to move higher. Where do we stand now? Overall the S&P 500 is technically sound as it is still in its upward trend channel and rising.
In fact the S&P 500 has just reached an all time high surpassing the tops of 2000 and 2007. The one concerning signal is that the volume has been declining as the market has been moving higher. In other words the rally is losing
support. Currently, the full stochastic oscillator is above 80 and if it were to move below this level, then this would be a sign that the price momentum to the downside is increasing.

What should seasonal investors do? Despite the fact that market has not broken down, given that we have entered into the unfavourable season for stocks, the risk-reward relationship favours a conservative stance in the markets, which includes raising cash, reducing beta and re-investing into seasonally strong sectors. The S&P 500 levels to the downside that investors should watch for are: 1597 (mid-April high) and 1525 (previous support line). If the market breaks down decisively below 1597 it will mean that market is probably going to suffer some volatility and will struggle to reach the current high again. If the S&P 500 breaks below 1525 it will mean that the market is in serious trouble and more downside risk lies ahead.

The six month market update’s unfavourable seasonal period for the S&P 500 started on Monday May 7th. The favourable six month seasonal period, from October 28 to May 5th, produced a strong gain of 14.3%. The S&P 500 maintained its strong performance right to the end and did not break down below its support level of 1525, as identified in my last newsletter. Despite the S&P 500’s strong performance, now that we have finished the six month favourable period, it is still prudent for seasonal investors to lower their risk in their portfolios.

Sell in May and Go Away….. It seems that every second article in the last week of April addressed this topic. It seems about half of the articles stated that this approach works and the other half stated that it does not. Can you imagine next year, how the number of articles discussing the topic will skyrocket if the summer proves to once again be the nemesis of the stock market.

To set the record straight, Sell in May and Go Away…. is not folklore. Last month I spent some ink illustrating that on average the next six months tends to perform poorly. Yes it has above a 50% chance of being positive, but compared to the fact that it produces an average geometric net loss (S&P 500, 1950 to 2012), larger losses and smaller gains than the favourable six month period, it is aptly named the unfavourable six month period.

The big argument in the market right now is whether cyclicals will outperform defensives or vice versa. The conventional wisdom is that when the defensives have been outperforming for a long time, that at some point the market is going to move back to a risk-on mode and that cyclicals will take over the lead. Although this is often true, this happens much less if the defensives have outperformed when the cyclicals seasonally outperform: in this case, the beginning of the year. On an average basis, since 1990 to 2012, when the defensive sectors (consumer staples, health care, and utilities) have outperformed the S&P 500 from March 1st to April 30th, they have also outperformed from May 6th to October 27th.

Regular readers will know that I have discussed this topic at this time of the year over the last two years.

The defensive sectors often outperform the cyclicals during the summer months and then a rotation takes place into the cyclicals in autumn. This is normal. On the other hand, it is not normal for the defensive sectors to outperform in the spring and often indicates that the stock market is prone to a correction.

More recently in the last two years, the market has followed the trend of defensive sectors outperforming in the spring, which has lead to a major correction in May.

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In this month I was torn between writing in the introduction about the developments in Europe and Japan, or the current market status as we approach the unfavourable season for equity markets. Although both are important, I deferred to discussing the transition that is taking place in the market. Nevertheless, what is going on in Europe and Japan is very important and I cannot help but discuss these events because of the long-term consequences.

They must be crazy

It seems that many of the high ranking officials in the European Union are patting themselves on the back for executing a “bail-in” scenario on the Cyprus banks. A “bailin” occurs when it is the depositors that pay for the banks bad debts instead of the taxpayers. The EU managed to “get away” with it because of the small size of Cyprus and its negligible effect on the EU. The whole exercise was badly planned as very large amounts of money were taken out of the banks before and during the crises, through subsidiary banks in other countries.

The EU officials were so pleased with themselves on how the bail-in worked, that some of them went on to say that this was going to be a template for similar situations in the future…..really I cannot believe the idiocy. Banks work on trust and you can bet that a whole lot of money is leaving Europe for banks in other countries where deposits are much safer.

If the EU tries this stunt one more time, very little money will be left in the banks of weaker European countries. The irony is that these countries are the ones that really need the money. Of course, officials in the EU back peddled on their “template” statements – there is no need to scare the ordinary European citizens.

Japan is manufacturing a Frankenstein

Japan is desperate. Their economy has been going nowhere for a very long time (decades). Small, constant amounts of fiscal and monetary policy seem to have had very little impact. Since 2007 the yen has been seen as a go-to currency in times of economic and financial trouble which has resulted in its appreciation. The government is clearly not happy with a rising yen as it hurts exports and as a result, they have decided to take aggressive action to lower its value. Sure…they will say that is to help the domestic economy, but we all know that it is designed to primarily to help boost exports.

I thought that Bernanke was crazy for increasing the monetary base so rapidly, but compared to Japan’s stated plans, Bernanke’s plans seems tame. Haruhiko Kuroda, the new governor of the Bank of Japan, is planning on doubling the monetary base in a year’s time. Monetary expansion of this magnitude has never been done before – it really is an experiment. Bernanke says that the U.S. will be able to quickly sop up the extra money supply when they need to. I do not believe him either. Kuroda believes that he can also sop up the extra money supply when needed. I do not believe him. In fact there is a significant possibility that the money supply will get away from him at the wrong time and cause unexpected problems down the road.

To compound the problem, Japan is an economic basket case with their debt to GDP ratio over 200%. This level is unsustainable and is higher than the European countries that had to be bailed out. The only reason that Japan has been able to get away with an “insane” debt to GDP ratio is that Japanese citizens have been loyal buyers of government bonds, helping to keep the interest rates down. In an aging nation that sells more adult diapers than baby diapers, this source of funding is dying off fast. As Japan will have to seek money from foreigners, who will demand higher interest payments, the Japanese debt will implode and cause financial chaos for the country. This might be in three years, or it might be in five years. I do not know, but the probability of this happening is strong. It will be like watching a slow motion train wreck.

On again – off again –On again

Recently, the Fed governors have been discussing whether or not the Fed should start to cut bank on its QE3 $85 billion a month bond buying program. As their statements have become public on one side of the argument or the other, the market has reacted. Recently, in March, the employment numbers were weak which prompted the governors to rethink curtailing the bond buying program. There is a possibility that the Feds may redirect the program
away from the “housing bonds” due to rising house prices being driven by easy money, but keep the overall magnitude of the program at $85 billion.

At this point, I am not expecting the Fed to curtail their program in the near future. With Japan cranking up their printing presses, Europe will not be far behind. The U.S. will not want to get caught with an overvalued currency and lose a global competitive advantage, so why slow the program down and then start it up again if currency wars develop? The U.S. will want to keep the door open so that they can participate in the “race to bottom.”

As I have said in the past, investors should not be making portfolio decisions solely based up global macro events. The stock market can diverge from the economic realities for quite some time. Instead, it is best to judge the interpretation of the events by looking at the market action. If the news is negative and the market responds positively, then this is bullish. If the news is positive and the market responds negatively, then this is bearish. Sometimes it is not the event that is important, but rather the reaction. Even more important for wise investors, of course,is to take into consideration the seasonal trends in making portfolio decisions. And with the market soon to be entering a period where it is best to be conservative, investors should take heed.

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When I do presentations across the country and mention seasonal strategies for bonds, nobody seems to be interested. Everyone has bought into the concept that the bull market is coming to an end. A lot of investment gurus have been preaching this for a few years. At some point in the future they may be right, but not just yet. Although it does not seem possible that the mid and long bond yield scan move any lower – they can.

Both U.S. and Canadian bonds have their seasonal period of strength from May 6th to October 3rd. In some years bonds can get a slow start in May and can start their outperformance a couple weeks after the S&P 500 peaks out in May. Investors should be patient with this trade as the real seasonal sweet spot occurs at the beginning of August. The government bond trade works well with the favourable/unfavourable seasonal strategy for stocks as it gives investors a place to use their cash.

The bond trade has worked well over the last three years in the unfavourable period for stocks. It is interesting to note that despite a consolidation at the start of the seasonal period for bonds, with IEF at the top of its range at the start of its seasonal period, the tarde still worked well. This year we have seen the same consolidation pattern and investors should not necessarily shy away from the trade just because we are once again at the top of the consolidation range.

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