Signs To Begin Selling

Turn the Page: With the calendar flipping to May, brace yourself for the flood of “Sell in May” articles. Statistically, in a down market, it does pay to reduce stock exposure from now until October, and given the recent bounce, it may not be a bad strategy. It is an opportunity to rebalance portfolios, lower risk, and put money into other asset classes besides equities. There are still so many unknowns from a policy perspective and an economic perspective that holding a little dry powder to reinvest is not only prudent, but likely an opportunity to buy depressed assets. 

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Xi’s Gone?

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Are we going to witness a China rug pull? Investors have welcomed news that the Chinese are open to talks, but China has made it clear that the trade war was launched by the U.S. and the onus is on Washington to walk things back before a dialogue begins. A translation of last week’s Commerce Ministry statement was quite clear:

·   The U.S. administration has made multiple requests to talk through various channels,

·   China is assessing the situation, and

·   For any meaningful discussions to begin, the “U.S. has to correct its wrongdoing first [remove unilateral tariffs] to show its sincerity to negotiate.”

When asked about the Ministry’s comment, Trump told NBC that he would not lower tariffs to get China to the negotiating table. He did concede that at some point he would lower them “because otherwise you can never do business with them.” Because he firmly sees China as the instigator of trade abuse, we expect delays before trade talks begin, which could frustrate the markets.

The need for a fast resolution is critical; that is certain. The question is, who is in a more desperate situation in this game of chicken, the U.S. or China? Small business is a strong GOP constituency, and the U.S. Chamber of Commerce asked for exclusions due to “unplanned tariff expenses, disruptions to products they need for assembly, and depletion of resources that threaten their [small businesses’] existence.” Sunday’s release of NBC’s Trump interview revealed his belief that small business will not need relief. China knows that President Trump will start to get pressured by GOP Congress members concerned about midterms. Meanwhile, the Chinese economy risks losing anywhere from 5-20 million jobs.

The longer-term problem is that finalizing the multiple layers behind these trade deals could take 12-18 months to negotiate, and far longer to roll out. Hopefully, the Economic and Trade Agreement signed by the two countries in 2020 but never implemented can help reduce significant delays. Given how far investor enthusiasm over trade progress has swung, any setback can result in a reversal in the equity rally.

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Zweig vs. Buffett

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Listening to Warren Buffett at his annual meeting yesterday, there is no rush to hop on the current rally. However, the Zweig Breadth Thrust indicator says the time to invest is now. Zweig’s indicator only triggers a buy signal when there is a major reversal from a severe oversold condition to widespread buying in a short two-week window. The signals come rarely and have a superb history of calling long-term market bottoms. Warren Buffett has a famous metric of his own, known as the Buffett Indicator, measuring the total market cap of all U.S. stocks (Wilshire 5000 Index) divided by GDP, and it points to more pain to come.

The Buffett Indicator closed last year at 211%, and is now 180%, which oddly has prompted a few to call that a buy, because the gauge bottomed in that region in August during the Yen carry trade panic. However, we prefer to listen to the man himself, who was discussing Berkshire’s cash pile of $348 billion, which is 27% of total assets, double its historical average.

Every now and then, you find something. Very occasionally. But it will happen again, and I don’t know when, it could be next week, it could be 5 years off…we will be bombarded by offerings that we will be glad we will have the cash for. It would be a lot more fun if it were to happen tomorrow, but it is very unlikely it will happen tomorrow, very, very unlikely it will happen tomorrow, but it is not unlikely to happen in 5 years.

We continue to track Pave’s risk factors that focus on leverage to pinpoint when capital is flowing into companies that hold substantial amounts of debt, which historically happens when a business cycle upturn is imminent. When high operating leverage stocks and other economically sensitive stocks begin to increase their ranking in our models, that will be a signal to increase exposure, and we would not be surprised that it would coincide with Buffett deploying some of Berkshire’s cash.

Technically, we see resistance starting at Friday’s high of  5700 extending up to 5775-5800 in the S&P 500 Index. If you are concerned about stagflation deepening, then becoming more defensive into that zone is one strategy. A move below 5585 is the first sign of trouble, but the Zweig signal was triggered when the S&P closed at 5484, so intermediate players could consider a close below 5480 as actionable. Longer-term players can wait until a break of 5300, with confirmation below 5150. If so inclined, another tactic is to wait for a particular support level to break and then sell bounces.

In our decades of watching those who second guess Warren Buffett, it rarely pays off. Therefore, become attentive if the above support levels begin to fail. If the S&P 500 forward price/earnings ratio falls from its current 20x down to 15x (where it was troughed at the market low in 2022) and top-down earnings estimates hold at $275 for the S&P 500, that targets 4125. If we see a recession and actual earnings over the next four quarters fall to $250, that equates to 3750. 

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How Low Can You Go?

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Fitting with the Zweig signal, retail investors have been buying the dip. Yet, market sentiment surveys have been going the other way, aligning with Warren’s outlook. The American Association of Individual Investors (AAII) survey ending April 30 shows only 21% of their respondents are bullish. Bears have polled above 50% for 10 consecutive weeks, the longest streak of bearishness in the 38-year history of the survey. Notably, this happened during a 15% rally from the April lows. The recent three week rebound is being viewed by AAII as a dead-cat bounce, not the start of a new bull market.

The rising bearishness is understandable, as investors expect empty shelves to be just around the corner. However, from a contrarian viewpoint, this degree of doubt in the market’s recovery is bullish. The AAII survey also had bears digging in their heels after the major equity lows of October 2022. The S&P 500 rallied 17% over a few weeks while AAII bullishness fell further. The October 2022 selloff hit price lows that have never been revisited since. If the current rally is for real, then the bullish readings should rise soon.

Professional investors just matched their deepest pessimism since those very same major lows of October 2022. However, those lows in the National Association of Active Investment Managers (NAAIM) survey coincided with last month’s lows in the S&P. As stocks have rallied, the NAAIM survey has risen consistently into their latest April 30 reading, similar to the pattern back in October 2022. With institutional sentiment rising and retail investors still fearful, we are not surprised at the most recent rally. Pullbacks are to be expected after the current sharp reversal higher, but if declines unfold in an overlapping, corrective manner, the sentiment landscape suggests April lows should stay intact. The keyword is “corrective.”  We will be on alert for a more impulsive selloff, if that happens.

What to Look for This Week

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(All times D.S.T.) 

1. Wednesday, May 7 at 2:00 a.m. the FOMC Interest Rate Decision followed in 30 minutes by Fed Chair Powell’s press conference. No chance of a rate cut, but Powell is now talking stagflation, so we will see if that thread continues in the press room and look for any hints about how long a rate pause could last.

2.  Tuesday, May 6 at 1:00 p.m. the Treasury auctions the 10-year note. Monday, May 5 at 1:00 p.m. is the 3-year note, and Wednesday May 7 is the 30-year bond auction, also at 1:00 p.m., just before the FOMC statement. If there is strong demand for bonds, that could help equity markets, but tepid demand will hurt the dollar and increase downside stock volatility

3.  Thursday, May 8 at 11:00 a.m. the New York Fed Survey of Consumer Expectations is released for April. The markets will be focused on 5-year Inflation Expectations because March data had a downtick to 2.9% from February’s 3.0%. The series has been remarkably stable and is the key FOMC indicator for consumer inflation expectations over a longer-term horizon.

FOMC Voters Speaking:  The logjam breaks Friday, May 9: Governor Barr speaks at 6:45 a.m., Governor Kugler at 8:30 a.m., with Governor Waller the one to watch at 11:30 a.m. on Monetary Policy Research. NY Fed President Williams speaks at 6:15 a.m. and again at 11:30 a.m. Chicago Fed President Goolsbee speaks at 10:00 a.m. and Governor Cook rounds it out at 1:45 a.m. We will look for a coordinated message after the dust settles Friday.

The Fed Senior Loan Officer Opinion Survey may be released this week or possibly early the following week, but there has been nothing specified. It will be worth reading.

Mannheim April Used Car Prices are released at 11:35 p.m. Wednesday, May 7 after the FOMC decision and could be noteworthy.

Thursday, May 8, at 7:00 a.m. the Bank of England releases its Interest Rate Decision, with a 25-basis point rate cut expected, and the minutes are released for this Monetary Policy Committee meeting. 

Earnings Note: Monday, May 5, after the close is Ford, which we are watching for more details on their decision to cease exporting to China. Palantir is also slated for Monday. Tuesday, May 6 after the market close is Advanced Micro Devices and Duke Energy. The latter may have updates on data center electricity projections post-tariff anxiety. Friday, May 9 Honda Motor Company, again, we will look for any insight regarding supply chain issues, or other tariff-related commentary.