Sell in May and Go Away?

In light of the improving macro outlook, we added Emerging Markets (EM) stocks while underweighting Europe, where weare more cautious on the macro upswing.
May 2019

Certain adages are hard to avoid in investing, and Sell-in-May-and-Go-Away is always a popular seasonal theme in May. This year more than usual, given that Canadian and U.S. stocks are at record highs. Although stock-market performance tends to be lower during the summer months, it’s still positive. For instance, looking back since 1988, the average monthly returns for the S&P TSX and S&P 500 are 1.2% and 0.9% from September until April, respectively, whereas they are 0.2% for both markets between May and August. Staying invested is crucial for long-term investors seeking capital appreciation. We believe balanced solutions provide sufficient diversification benefits, such that investors should not worry about seasonally timing markets and remain focused on their long-term investment goals, especially when the economic and political backdrop remains supportive.


Goldilocks and Hopes of Melt up in April

Investors enjoyed another solid monthly performance for global stocks in April as macroeconomic data was good enough to push out recession calls, yet again. Across the main regions, Japanese shares surged 5% after a less convincing first quarter. U.S. stocks posted another solid month as the S&P 500 rose 4.0% to break new highs, while the tech-focused Nasdaq 100 index jumped 5.5% as the global outlook proved more resilient than feared. Canadian shares rallied along with a 3.2% gain for the S&P TSX as the energy sector finally got another boost from oil prices, which rallied 6% in April. Year-to-date, the S&P 500 is up 18.2%, and up by 26% since the Christmas-Eve debacle. The clear pain trade this year is to be under invested in stocks when the central bankers are doing their best to keep the pump primed.

In fixed-income markets, the improving macro outlook helped drive yields a little higher on 10-year government bonds in Canada and the U.S. The more encouraging data also helped steepened the 2-10-year U.S. yield curve, which now sits 20bps above inversion, a 10bps increase from the prior month. The 3m-10-year part of the curve is also slightly in the black for the U.S., but the bulk of the Canadian yield curve remains inverted up to 10-years as growth expectations remain modest. For credit markets, the improving investor sentiment has help credit spreads narrow from their highs earlier this year when sentiment was dour (Chart 1).

Chart 1: Investment Grade and High Yield Spreads to U.S. Treasuries

Sell in May and Go Away Chart 1

Source: Bloomberg

The loonie fell modestly by 0.3% as surging oil prices were offset by the Bank of Canada’s downgrade of their outlook for the Canadian economy. Overall, currency markets were very quiet in April as investors lacked catalysts to break out of recent ranges driven by the surprising strength of the U.S dollar so far this year.


Equity-Factor Styles in Growth Mode

April’s equity-factor performance reflected the upbeat month for late-cycle risk appetite as Growth (+4.0%) and Quality (+3.6%) outperformed global stocks (ACWI, +3.2%) and the more defensive Value (+2.7%) and Low-Vol (+1.0%). Meanwhile, Small-Cap (+3.0%) and Momentum (+3.1%) performed in line with the broad market. 2019 year-to-date as of the end of April (Chart 2), Growth (+19.1%) and Quality (+19.1%) are well ahead of the broad market (+15.2%). Playing defense in global stocks via factor tilts has not been easy this year as Value (+12.9%) and Low-Vol (11.7%) have significantly lagged (Chart 2). Given that a good part of the rally this year has been fueled by renewed optimism within the context of a late-cycle narrative, the Growth and Quality leadership could persist into the second half of the year if goldilocks extends over the next 12-18 months.

Chart 2: Year-to-date Equity-Factor Returns

Sell in May and Go Away Chart 2

Source: Bloomberg, MSCI

In Canada, Low-Vol (ticker: ZLB, +2.0%) underperformed the broad market last month (ticker: ZCN, +3.3%) as the more volatile energy sector benefited from surging oil prices. However, we believe Low-Vol will outperform the broad Canadian market over coming months as oil prices trade within the $60 range. We look to add more Canadian Low-Vol to our portfolios heading into the summer.


Tariff-Man is Back: Could he ‘Murder’ the Cycle?

President Trump went ahead with his tariff threats on Chinese imports despite of sensitive trade negotiations. Heightened trade wars triggered a global stock-market selloff earlier this month. Trump’s public negotiating tactics using a shock-and-awe style is not new. The NAFTA re-negotiations last year certainly involved a lot of unnecessary drama before reaching a deal. Despite all this noise, we think a trade agreement will be reached over coming months, but the sooner the better for investors. Trump’s tactics certainly raise the scope for added uncertainty, which is why our overweight to equities remains prudently modest. Ultimately, we think Trump will seek re-election on a strong economic and stock market performance. Escalating trade wars could risk derailing the economy and compromise his re-election ambition.


Is the Fed Ruining the Goldilocks?

At the April FOMC (Federal Open Market Committee) meeting, Fed Chair Powell surprised a dovish-leaning market by re-enforcing his view that tepid inflation was “transitory”, which took the equity markets into a tailspin. To the extent that U.S. interest-rate markets were expecting the Fed to cut rates by year-end despite encouraging macro-economic data, we are not surprised the market may have to push out calls for cuts to 2020, at the earliest.

We don’t think the Fed is killing the cycle or goldilocks by steering markets away from thinking rate cuts are imminent, but it might have reduced the odds of a melt-up scenario. While we continue to think the next move by the Fed is a hike, not a cut, we are also cognisant that the Fed’s upcoming messaging will be crucial for maintaining investor confidence and keep the bull market alive. This is why we also think the Fed’s messaging will be tuned such that a replay of the fourth-quarter drama is avoided. Finally, if trade wars were to have a material negative impact on the growth outlook, we would expect a prompt response from the Fed with at least a couple rate cuts.


Is the Bank of Canada too Optimistic—Again?

For Canada, our view on the monetary-policy outlook is unchanged as the Bank of Canada (BoC) continues to believe the domestic growth slowdown will be transitory. While we don’t see a recession in Canada over the next 18 months, we doubt the reasons behind the slowdown are as transitory as the BoC believes. However, we agree that growth should pick-up somewhat in the second half, but we doubt it will be strong enough to justify a rate hike in the next 12 months.

Overall, it seems the BoC is not afraid of another round of serial disappointment by expressing a relatively optimistic view for a strong enough rebound which would justify further rate hikes. Unlike our view of the Fed, it’s hard to have the same conviction that the next policy move in Canada could be a hike, we feel split on this.


Could Inflation ‘Murder’ the Cycle?

Surging inflation is rarely well received by financial markets as it usually brings monetary-policy tightening and negatively impacts profit margins. However, the problem for central bankers in the past 6 years has been a lack of inflation vis-à-vis their targets (Chart 3), despite the trillions of dollars in central-bank asset purchases since the great financial crisis and relatively loose fiscal policies. We disagree with the Fed’s view that the weak inflation is transitory when it’s been undershooting expectations year after year.

An interesting theme that transpired from the latest earnings season is that some companies have commented about having more pricing power than they have had so far in this cycle. On balance we think demographic and technology-driven disruptive trends will continue to weigh on inflation and should limit upside risks absent of further wage pressures, due to labour and skill shortages, or import tariffs that could arise form heightened trade tensions.

Chart 3: Canada, U.S., Euro-Area Core Inflation (y/y)

Sell in May and Go Away Chart 3

Source: Bloomberg

Recession Fears Take a Blow, But Speed bumps Ahead

Fears of an imminent recession took another blow with U.S GDP growth registering a 3.2% annualised pace in the first quarter despite the U.S. government shutdown, trade wars and a shaky sentiment coming off the fourth quarter. The U.S. job market has also outperformed expectations lately and continues to underpin a solid outlook for household expenditure. Keep in mind that as recently as early March, optimism was still running low as both the market consensus and a popular measure of current U.S. GDP growth expectations from the Atlanta Fed were calling for sub-1% Q1 growth.

Meanwhile, growth in Canada should continue to significantly lag the U.S. and although the gap should narrow a little in the second half the year, we don’t see Canada outpacing the U.S. over the next 18-24 months. Last month, our investment thesis called for a re-acceleration of U.S. growth during the second half the year, but it looks like the pace of U.S. growth in the first half of the year will easily be above 2% after all. Meanwhile, Canada will be lucky to average more than 1% growth during the first half.


Lowered Expectations Delivered a Decent Earnings Season

The recent earnings season in Canada and the U.S. delivered another dose of confidence to investors. Roughly three quarters of S&P 500 firms reported better-than-expected earnings, which is a little better than the 5-year average. S&P 500 revenue growth topped 5% versus last year. However, guidance in the U.S. remains subdued and firms have so far been hesitant to commit to the re-acceleration thesis. Keeping expectations low remains a strong theme for firms. Meanwhile earnings expectations in Canada have improved significantly for 2019 and 2020, notably due to the recent upswing in energy prices, though we think that is well priced already, whereas we think oil prices will struggle to break above $70 per barrel over the summer without further supply disruptions.


Outlook and Positioning: Steady Equity Overweight

We remain slightly overweight to equities, unchanged from last month, and we continue to some see upside to global stocks while interest rates should remain pressured upward as economic activity confirms a continued expansion of the cycle, especially after the negative market reactions to tariff hikes. In light of a firmer global outlook, which should weigh on the Dollar, we moved to a small overweight to EM stocks while underweighting Europe, which will be lucky to hit 1% growth this year. Finally, we are keeping an overweight to U.S. stocks as we think the resilient U.S. growth will provide an earnings uptick in the second half of the year. Deescalating trade tensions between China and the U.S. should support investor sentiment as well.

In fixed income, we remain underweight to credit as spreads have narrowed back to tight levels (Chart 1). We continue to see the credit market as the best way to express some defense outside of government bonds given where spreads are and how they could react under unforeseen stress. Our small underweight to duration is intact and last month’s uptick in yields confirmed our view that yields had overreacted by aggressively pricing in rate cuts for 2019. However we doubt yields will back up like they did last year when 10-year U.S. treasury notes touched 3.25%. We think it would take a lot of good news to get them back up to 2.75% before year end.

Finally, we maintain our call for a $0.73 loonie for the summer, which should be easier to achieve if our call for a top on oil is correct. The other big surprise this year is the resilience of the greenback as the U.S. leadership remains intact. Given that the Dollar is highly pro-cyclical and that some of the recent Dollar strength came along with softening economic activity, we think we are near the top for the Dollar as we expect an upswing in global PMIs during the summer (Chart 4).

Chart 4: U.S. Dollar Index and JPM Global Manufacturing PMI

Sell in May and Go Away Chart 4

Source: Bloomberg

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