History: Something does not become a maxim unless it has shown to have some predictive use. This seasonal switching strategy may not make much sense on the surface (kind of the like the Super Bowl indicator), but history shows it has some accuracy. Interestingly it seems to work even better with the European Indexes. (For more, click here.)
Europe: Today began with the news that Portugal would be the latest country to seek a bailout, joining Greece and Ireland. In one of my previous Seeking Alpha articles I had predicted this would happen by June. This means Spain will now be the target of speculation of who is next in line for a bailout. As stated in the article, I do not see how Spain makes it to the end of the year without going hat in hand to the European Union. Its banks simply have too much debt, it has a huge housing overhang, unemployment is already close to 20%, and the ECB raising interest rates certainly will not help its economic growth prospects. This is not going to be good for the markets, and could trigger another liquidity crisis although hopefully much less than what we experienced in 2008.
Middle East and oil: The Middle East continues to be in turmoil. Libya is in a civil war. Yemen, Bahrain, Oman, Syria and Pakistan are having significant protests. Egypt has the potential to have its nascent democracy movement be high-jacked by fundamental Islamists. This unrest is the main driver of the recent rise in oil and gas prices. Gas is nearing $4/gallon and is up over 20% since the first of year, hitting a 2 1/2 year peak. Both inflation and consumer spending are likely to continue to be negatively impacted by these increases. If Nigeria elections in May are postponed or go badly, oil prices are likely to shoot up even further given that country’s contribution to world oil supplies.
Consumer spending: Consumer sentiment is at a year low, fuel prices continue to march upward, and although job growth is starting to accelerate; wages are not. In addition, inflation is hitting the consumer much harder than government measurements are reporting, especially in energy and food prices. The impact to consumer spending is likely to be extremely negative as consumers find their dollars buying less at the pump and in the food aisle.
The end of QE2: I believe there is next to no chance this program will be extended past June given its marginal impact on economic growth and jobs, its hugely negative impact on inflation, and the changing political dynamic. When this program ends in June, I believe high beta stocks will have a significant pullback, interest rates will rise, and commodities will have at least a temporary sell off as a lot of this excess liquidity went into that asset class.
Prognosis: Given the risks listed above, I would be very cautious here. We may get a bump from April’s earnings announcements and what is left in QE2, but we are likely to hit some major turmoil and a good sized pullback in the summer which would be a better opportunity to deploy money into the market. In the meantime, I continue to hold some funds in TBT, have significant amounts of my portfolio in cash and blue chip stocks that have significant international and emerging market exposure (Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), Microsoft (NASDAQ:MSFT)) and am avoiding high beta stocks like Baidu (NASDAQ:BIDU), Salesforce.com (NYSE:CRM) and Lululemon (NASDAQ:LULU) like the plague. Be careful out there.
Disclosure: I am long MSFT, JNJ, XOM.