Stay in May and Go Away?

Wall Street stock strategists like to come up with catchy phrases to describe their current investment strategy.

Phrases like "don't fight the tape" (i.e. follow the current market trends) or "no one every went broke taking profits" have long been a staple of presentations that I have attended over the years.

More recently, however, I have heard the axiom "Sell in May and Go Away" repeated on several occasions.

Historical data going back to 1945 indicates a remarkable tendency for markets to do very well in the first part of the year, only to give back most if not all of the gains during the summer months.

Often the market rallies in the final quarter of the year, giving the appearance that buy-and-hold is usually the best approach, yet the data would suggest simply selling all of your stocks in the spring, and reinvesting at the end of the third quarter, would be a better approach.

In 2010 and 2011 the S & P 500 saw solid gains in the first four months of the year followed by fairly significant "corrections" during the summer months.  Fortunately, both years ended with strong rallies, but the pattern of the past couple of years has lead many investors to wonder if they should be selling stocks now.

Well, perhaps, but I wanted to offer a couple of thoughts that might make 2012 different.

First, Merrill Lynch research analyst Stephen Suttmeier looked at data going back to 1928 and found the following:

The Presidential Election year is usually not a "sell in May and go away year". During a Presidential Election year May through October generally has had an above average return, while November through April has had a below average return....

Using average monthly data, the weakest period of an Election year has been April and May, and this is followed by the strongest three month period of an Election year, June, July and August.  This suggests a potential summer rally in 2012.

Then there was piece written by Paul Lim in last Sunday's New York Times about the seasonal effect on stock market returns.

In 2011, global fears over inflation, especially surrounding elevated food costs in the emerging markets, led central banks around the world to raise interest rates. This year, policy makers in many of those same places — including China and India, and even Europe, at the European Central Bank — have been lowering rates to jump-start growth. Just last week, the Reserve Bank of Australia slashed rates by half a percentage point, citing a weak economy and mild inflationary pressures...

 Meanwhile, the corporate earnings picture looks much brighter than it did as recently as a month ago. In April, Wall Street analysts were forecasting flat profit growth of less than 1 percent for companies in the S.& P. 500 in the first quarter. But with around 85percent of those companies having reported their results, consensus forecasts for earnings growth have been ratcheted up to 7.2 percent.

http://www.nytimes.com/2012/05/06/your-money/another-may-another-stock-market-decline-maybe-not.html?_r=1&scp=1&sq=Paul%20LIm&st=Search

In other words, in this year at least, there is probably sufficient reason to just sit tight.

Stocks Rise As A Socialist Becomes Head of France

My post last week indicating that I thought there was a real opportunity developing in European stocks has been met with polite skepticism, to put it mildly.

My colleagues noted the long list of issues confronting countries in the euro zone.  In particular, European banks are still in a precarious position, holding billions of questionable euro zone credits mostly related to the real estate bubble that developed in countries like Spain during the last decade.

Friends and clients remain largely unconvinced as well.  Pictures of riots in the streets of places like Athens and Barcelona are hardly confidence-inspiring.

And the election of the socialist candidate Francois Hollande in France over the weekend doesn't exactly excite the animal spirits of capitalist investors.

Yet I still think that a considerable amount of "bad news" is already priced into the European markets.

As I wrote last week, most of the stock markets in Europe are trading at the very low end of valuations over the last 10 years.  Meanwhile, corporate earnings expectations for many European companies are being moved higher.

It's not only voters that are calling for a rejection of Germany's calls for austerity. Comments from several senior policy members in several European countries have now decided that growth, not cutbacks, are the way to stimulate Europe's moribund economies.

For example, here was an excerpt from this Saturday's Financial Times:

Senior European officials are championing an investment pact to stimulate growth in the eurozone as voters in France and Greece look set to punish leaders who have backed austerity measures.

In a marked shift of emphasis, Olli Rehn, the {European Union}'s top economic official, will today call for additional government spending for large-scale infrastructure projects, arguing that there is not sufficient private-sector demand to create jobs.

http://www.ft.com/home/us

So on top of a significant divergence between market valuation and company fundamentals, investors in Europe might also find significant fiscal stimulus helping corporate earnings in the coming quarters.

However, for now at least, I still face a number of euro-skeptics.

Who Would've Thought? Municipalities Running Surpluses, Paying Down Debt

A couple of years ago, in December 2010, famed Wall Street analyst Meredith Whitney appeared on the CBS news program 60 Minutes.

Ms. Whitney had made her reputation based on her correct assessment of the dire straits of the US banking system in 2007.  She had subsequently started her own firm.

In 2010 she had turned her attention to a study of the municipal bond market in the United States, and she didn't like what she found.

Here's what she told Steve Kroft of 60 Minutes on that December night:

"You could 50 to 100 {municipal bond} sizable defaults, {maybe} more...It'll be something to worry about within the next 12 months"

The municipal bond market was rocked on the Monday following her appearance.  Investors sold in troves based largely on Ms. Whitney's comments, and municipal bond yields soared.

As it turned out, however, the municipal market was relatively complacent in 2011, and actual default activity declined last year.

News reports released yesterday indicated that rather than plunging further into debt, a number of states and local municipalities reported significantly improved finances.

In fact, more than half of the 50 states are now projected to show budget surpluses for their fiscal years, which end June 30. 

States and local governments did exactly what you might expect they would do - reduce costs - and as the economy improved, tax revenues moved nicely higher.

Here's how Reuters reported it this morning:

The National Conference of State Legislatures reported that 29 states and the District of Columbia project their fiscal 2012 revenue will exceed budgeted obligations by $9.1 billion. For most states, the fiscal year ends June 30....


..."Spending requirements have been relatively stable, and revenues continue to grow, and in some cases have returned to pre-recession levels," it added.

http://www.reuters.com/article/2012/05/03/usa-states-budgets-idUSL1E8G3FB920120503 

The Reuters report goes on to say that while many local governments remain cautiously optimistic,  most remain concerned about the continued rapid growth of Medicaid. 

In addition, huge legacy municipal pension and health care obligations continue to loom large in the future, so it is too early to issue the "all clear" on concerns on municipal credits.

However, for now, at least, the trend in municipal credit quality seems to be going in the right direction.

Contrarian Alert: Take A Look At European Stocks

Remember March of 2009?*

The world was an ugly place. The S&P 500 had retraced all of its gains achieved over the prior 12 years, and stood at levels not seen since 1997

Each day the market seemed to be cascading lower; the S&P lost -12% during the first quarter of 2009.

And the price/book of the stocks in the S&P stood at multi-generational lows.

It was hard to find anyone bullish on stocks in 2009.  Instead, books were being published celebrating the sagacity of hedge funds managers who had made billions of dollars betting against the U.S. housing market.

So now, three years later, the S&P has doubled in value since the March 2009 lows, trouncing the returns of both gold and bonds.

What happened?

Lots of events, but most of them emanating from Washington.  The Fed flooded the system with liquidity, and backstopped all bank deposits.  Financial Armageddon was averted.

The fiscal side of the house did its part, too, with a massive stimulus package of nearly $1 trillion.

And I would argue one other event was occurring that was largely obscured at the time.

Corporate America was getting its house in order.  Although profit margins were already at healthy levels, corporations used a combination of technology and cost reductions (i.e., layoffs) to maintain profitability even if sales growth was sluggish or declining.

So when the government's stimulus efforts worked, corporate profits rebounded sharply, and stock prices climbed accordingly.

Why am I going through all of this recent history?

I believe we may be setting up for another opportunity, but this time in Europe.

Oh, I know what you're thinking: Doesn't Glen read the papers?

Civil unrest is rampant across the European continent as unemployment reaches record levels.  Governments from the Netherlands, Italy and, this weekend, probably France are being turned out of office by frustrated voters.  The euro zone is being held together by a massive liquidity infusion by the European Central Bank.

Yet Germany - the key player in the euro zone - continues to insist on more austerity measures.

Here's where the Cyrano Effect comes in.

Analyst Laszlo Birinyi first came up with this term.  When problems are as obvious as the nose on your face, Mr. Birinyi noted, they are most likely already reflected in stock prices.

So it is in Europe today, I believe.

According to Kevin Gardiner, head of European Investment strategy at Barclays, the stocks in most European markets are trading at 10 year lows, using price/book as valuation.

But here's the thing:  Earnings estimates for European companies are going higher, not lower.

Isn't this what investors should be looking for?:

Rising earnings estimates + cheap valuation = Opportunity

In addition, I have a feeling that the austerity regime in Europe will be moderating in the next few months.

It's no fun being head of a country when people are rioting outside of your office, demanding action to reduce unemployment and spur economic growth.

In other words, I see several similarities between the U.S. in 2009 and Europe in 2012:

• Lots of central bank intervention - check.
• Corporate balance sheets improving, and cost cutting implemented - check.
• Fiscal stimulus - not yet, but probably coming.
• Widespread pessimism - check.

I'm not saying the markets will move sharply higher in Europe, but I suspect they may be due for a fairly significant move higher in the next few months.

Sentiment is so negative that any good news is dismissed - the classic sign of capitulation that investors with a long term time horizon should welcome.

Just think back to how you felt in 2009 - and what the markets subsequently did.

*Of course you do, and so does most of the adult population of the U.S. That's why outflows from domestic equity mutual funds were the highest in 16 years in the month of April, according to Merrill Lynch.

Dr. Gupta At Michigan

I always thought that Steve Jobs's 2005 Stanford commencement speech was one of the best I ever heard.

However, Sanjay Gupta - a doctor by training who often reports on medical issues  on CNN - gave the 2012 commencement address at the University of Michigan (my alma mater) last weekend, and I thought it was just great.

Take a look when you get a minute:



Valerie Stauss of the Washington Post wrote about Dr. Gupta's talk earlier this week. Here's an excerpt from what she said:

“Simply being here,” he said at the beginning, “is incredibly personal for me. You see, not only was the foundation for most of my life conceived in this town. I myself was likely conceived in this town. Best bet is the 17th floor of the University Towers though no one is talking still even after 43 years.”

Then he proceeded to tell an amazing story about how his mother, a new immigrant to the United States, was driving through Ann Arbor when her car broke down. Knowing no one, she went to a phone booth (yes, they had them in the mid-1960s), took the telephone book inside and found an Indian name starting with the letter ‘A.
’
The person who lived at the phone number she dialed wasn’t home, but the young man who did answer wound up becoming her husband and Gupta’s father. It was sheer luck that he liked fixing cars.

http://www.washingtonpost.com/blogs/answer-sheet/post/sanjay-guptas-great-speech-at-u-michigan-commencement/2012/04/29/gIQA3kdcqT_blog.html

What To Do With Apple Stock?

If there is one challenge for institutional equity investors these days, it is trying to figure out how much, if any, portfolios should hold in Apple (AAPL).

Apple currently represents 4.3% of the S&P 500.  If you didn't hold Apple in your portfolio in the first quarter of 2012, you probably underperformed the benchmark.

Apple rose almost +50% (!) in the first three months of this year, and contributed almost +2% to the S&P's overall gain of +13% in the first quarter.

Apple's stock price has come off slightly since the end of March despite posting almost unbelievable first quarter results.

Still, with the incredible sales momentum the company currently enjoys (just ask  Nokia, which is suffering great losses at the hands of Apple), it seems hard to bet against the company.

Relative to its growth rate, Apple is a very cheap stock.

AAPL trades at just 12x earnings, which is near the lower end of its valuation range; the last time it traded at this level was in the spring of 2009, in the depths of the U.S. recession.

The company now offers investors a 1.8% dividend yield.  Given the fact that it ended the first quarter with an incredible $110 billion in cash, it is an understatement to say that the dividend has room to expand.

But there will be a time to sell Apple, as is true with most stocks.

If nothing else, the "law of large numbers" will begin to work against the company. 

Apple is now the largest company by market capitalization in the U.S.: nearly $550 billion, or more than IBM and Microsoft combined. While it is obviously an amazing company, for example,  it is hard to imagine any company growing to be worth $1 trillion.

So it was with interest that I headed over to Barclays yesterday to hear Ben Reitzes, who follows the Information Technology (IT) hardware space for the brokerage firm, which of course includes Apple.

I have written about Ben before on this blog.  He is a first-class analyst, and is not afraid to hold contrarian views on the stocks he follows.  His conclusions are based on numerous studies not only of the financials but also on regular "field checks" as a reality checks.

Ben has had a "buy" on Apple for 7 of the 10 years that he has been following the company.

While he acknowledges that Apple's huge market cap presents a significant challenge to further stock appreciation, he continues to believe that investors should be buying the stock.

He has a price target of $750 on the stock, which represents another +27% upside if he is right.

Ben argument is simple:  the IT space is now dominated by Apple.  The company has created such a dominance in the internet ecosphere that it is hard to imagine any company seriously challenging Apple in the foreseeable future.

In his view, the IT world breaks down into three sectors:  Apple, and companies that work well with Apple (especially EMC); those that are the big losers in the fight against Apple (Dell and Nokia especially); and those that are not directly impacted by Apple but probably will not enjoy the same rate of growth as Apple (IBM comes to mind).

So, Ben, someone asked:  When should you sell Apple?

In his view, there are two main risks.  First, at some point the company's dominance will attract the attention of the U.S. Justice Department.  Anti-trust investigations derailed Microsoft in the 1990's, and IBM before that, and the day will probably come when Apple's size attracts legal attention as well.

Second, if Apple's legendary customer service ever begins to falter, Ben would start to worry as well.  Right now, going to an Apple retail store remains for most people a "wow" experience; if this attention to customer satisfaction gives way to complacency, Ben would be a seller of the stock.

But for now, Ben says, hold on for the ride.

Two Princeton Professors Have At It

If you grew up as I did - with two professors as parents - you learn pretty quickly that intellectual arguments in academia can be pretty intense.

Henry Kissinger once famously observed that "University politics are vicious precisely because the stakes are so small." Professors tend to be very smart, very opinionated, and not afraid to challenge authority, especially if they have tenure.

Before he became chairman of the Federal Reserve, Ben Bernanke was chairman of the economics department at Princeton University. Among the professors that Dr. Bernanke recruited and hired for Princeton was Paul Krugman, the Nobel Prize winning economist who also writes frequently for the New York Times.

Krugman has become a frequent critic of his former department chair's policies.  He feels that the Fed should be doing more to spur economic growth in the U.S. through more aggressive use of monetary policy.

Dr. Krugman has written a book entitled "End this Depression Now!" that is scheduled to be published in May.  An article adapted from his book was written in yesterday's New York Times magazine.

Krugman argues that there is a major disconnect between what Professor Bernanke thought monetary policy could accomplish, and what Chairman Bernanke is actually doing as head of the Federal Reserve.

He notes that Bernanke was very vocal in his criticism of the Bank of Japan throughout much of the 1990's for what Bernanke perceived to be a timid response to Japan's economic woes.

However, now that he is head of our country's central bank, Krugman believes that Bernanke is acting more like the bank mandarins in Japan that he once attacked.

Here's an excerpt:

The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker. Whichever account you prefer, however, the fact is that the Fed isn’t doing the job many economists expected it to do, and a result is mass suffering for American workers. 

http://www.nytimes.com/2012/04/29/magazine/chairman-bernanke-should-listen-to-professor-bernanke.html?_r=1&src=me&ref=magazine

Last Thursday, at a regular press conference, Chairman Bernanke was asked to comment on his former colleague's views.

Ezra Klein of the Washington Post reported Bernanke's thoughts.  It's a fairly long quote, but I think it is worth repeating here:

There’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies...the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And clearly, when you’re in deflation and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.

Now, why don’t we do more? Well, first, I would again reiterate that we are doing a great deal -- policies extraordinarily accommodative; we -- and I won’t go through the list again, but you know all the things that we have done -- to try to provide support to the economy.

I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless. We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

http://www.washingtonpost.com/blogs/ezra-klein/post/ben-bernanke-vs-paul-krugman/2012/04/26/gIQAPcXfjT_blog.html

Far be it from me to get in the middle of an intellectual squabble between two eminent economists (my parents taught me well!), but here's my two cents:

It seems to me that the Fed has done an extraordinary amount under very difficult circumstances.  While it is easy to write from Princeton that the Fed should do more, recall that Bernanke's confirmation hearing was not an easy one, and his Senate approval was only a tepid victory.

Moreover, I am not sure that lower interest rates really would accomplish that much more.  Mortgage rates, for example, are already at historic lows, and housing affordability is at near-record highs.  Lower rates have allowed corporations to borrow at very attractive levels, yet much of the cash still sits on the sidelines.  Monetary policy cannot force companies to invest in plant and equipment that they do not need.

 Oh, by the way, whatever happened to using fiscal policy for economic stimulus?