Sell In June Before The Debt Eats You

|
Includes: ADP, DIA, GLD, IWM, MCO, QQQ, SPY
by: Michael Bryant
Summary

The Dow and Russell 2000 appear to be peaking, but the S&P 500 and NASDAQ could go a little higher.

But valuations seem to be too high for the current economic climate.

Watch out for debt.

It appears that investors have not sold in May and gone away. But will they before summer is over? "Sell in May and go away" refers to May 1-October 31, and the strategy has worked 86% of the time for the Dow since 1950. Are there any warning signs?

In my January 4 article, I gave many potential market peaks, and one peak was 21,500 for the Dow (NYSEARCA:DIA) by the end of June. But the exact peak target is 21,560 by (correction) October of 2018. The Dow ended Friday at 21,206. Assuming it rises to 21,560, the Dow would settle at 17,291 if it fell 19.8% as I mentioned in the article. That would take us back to June 27, 2016. The Dow was at 17,888 on Election Day, November 8. Thus, a 19.8% fall would wipe out the entire Trump Rally and take another 600 points off the Dow.

Source: Google Finance

Using the same bullish rounded bottom technical indicator for the S&P 500 (NYSEARCA:SPY) gives a peak target of 2,431 by October of 2018. The timing of the peak target is 1 year and 3 months away, but the value is extremely close to the Friday's close of 2,439. Assuming it peaks at Friday's close, the S&P 500 would settle at 1,956 if it fell 19.8%.

Source: Google Finance

The bullish rounded bottom technical indicator for the Russell 2000 (NYSEARCA:IWM) gives a peak target of 1,341 by October 2018. The timing of the peak target is 1 year and 3 months away, but the value is actually below the Friday's close of 1,405. Assuming it peaks at Friday's close, the Russell 2000 would settle at 1,126 if it fell 19.8%.

Source: Yahoo Finance

In my April 4 article, I gave targets for the Dow, S&P 500, NASDAQ (NASDAQ:QQQ), and Russell 2000 at 18,250 by June/July, 2,100 by June/July, 4,450 by October/November, and 885 by November/December respectively. In my May 2 article, I gave targets for the Dow, S&P 500, and Russell 2000 at 19,700 by June/July, 2,260 by June/July, and 1,280 by June/July respectively.

Source: Stockcharts.com

The Dow formed a bearish double top, and the target would be 19,560 in about 3-4 months, a decline of 7.76%. Note that the target is slightly below the 200 day moving average, which was close to the market bottom around the election. The W%R is very overbought, and the RSI is close to overbought.

Source: Stockcharts.com

The S&P 500 formed a bullish ascending triangle, and the target would be 2,470 in about 1.5-2.5 months, a rise of 1.27%. The W%R is very overbought, and the RSI is overbought. Thus, the price would likely fall to support at 2,368 before heading higher.

Source: Stockcharts.com

The NASDAQ formed a bullish rounded bottom, and the target would be 6,380 in about 0.5-1.5 months, a rise of 1.19%. The W%R is very overbought, and the RSI is overbought. Thus, the price would likely fall to support at 6,080 before heading higher.

Source: Stockcharts.com

The Russell 2000 seems to be range bound and will likely fall to support at 1,345. It was very close to forming a bearish double top with a target at 1,270 in about 1-2 months, a decline of 9.61%. The W%R is overbought, while the RSI is close to overbought.

Valuation-wise, the market seems overbought with S&P 500's PE ratio at 25.80, up from 25.22. The only times it reached that high was during the Tech Bubble, the Credit Crisis, the Panic of 1893, which saw a decline of 32%. The Shiller PE ratio rose to 29.88 from 29.29 a month ago. It was about 30 on Black Tuesday, which saw a crash of 23%. Thus, the peak seems very close. At the current rate of increase, the Shiller PE could reach 30 by the beginning of next month.

While payroll processor Automatic Data Processing (NASDAQ:ADP) reported that the private sector added an estimated 253,000 jobs in May, the government reported that job growth slowed to 138,000. Economists estimated that the economy would add 185,000 nonfarm jobs in May. March's job gains were cut to 50,000 from 79,000. April's jobs gains were cut to 174,000 from 211,000. Thus, the labor market is not as strong as expected. Further, the miss of 47,000 nonfarm jobs was nearly 115,000 jobs below the ADP report. Why? One possible explanation is that public jobs declined. The government's jobs report showed that government jobs decreased by 9,000 in May. Another explanation is that people are working two jobs since they would be counted twice by the payroll report.

If people are working two jobs is true, this does not seem to be a strong labor market. It also seems that people need to work two jobs to make a living. This could eventually hurt spending, which is bad news as consumer spending drives the economy. So far, spending has managed to jump to 0.4% in April from 0.1% in January and February. But spending may have hit resistance and could fall in the coming months. A similar situation happened between 2010 and 2012. Further, spending only averaged 0.54% from 1959 until 2017, so 0.4% is getting close to the average.

Source: U.S. personal spending 2007-2017

The unemployment rate fell to 4.3% due to more people leaving the labor force, not more people finding a job. In May, the labor force participation rate was 62.7%. Could the labor force participation rate reach 60% as in the early 1970s? The participation rate seems to be on a downtrend partly due to discouraged workers and partly due to retiring baby boomers. The rate is currently at resistance and could head lower.

Source: Business Insider

Somehow the unemployment rate always reaches a minimum just before a recession, as fellow contributor Naveen Musunuru pointed out in 2008. While the unemployment rate reached the same level it was at before the credit crisis, technically the unemployment rate could fall lower.

Source: Unemployment Rate from 1947-2017

Despite weeks of political turmoil in Washington, the stock market has kept going higher. But this week could be the beginning of a slow market fall. Fired FBI Director James Comey is set to testify before the Senate Intelligence Committee on Thursday, June 8. Comey was fired during the FBI's investigation in Russia's meddling in the election. Trump mentioned "the Russia investigation as part of his reasoning behind dismissing Comey, leading Democrats, and some Republicans, to call for an investigation into whether the president obstructed justice."

As for the nation's debt, Congress passed the $1 trillion spending deal on Thursday May 4, and Trump signed it on Friday May 5, to keep the government open till October 1. As they did many times in the past several years, the bill was signed just hours before the deadline. So I will assume that the next spending bill will not be passed till the last minute. Trump has even said that the nation might need a shutdown in October to clean up the mess in Washington. But such a shutdown could cause Standard & Poor's to lower the nation's credit rating another notch to AA from AA+ like it did on August 6, 2011. Moody's (NYSE:MCO) kept its credit rating for the nation at AAA, but downgraded its outlook to negative on June 2, 2011. Fitch also kept its credit rating for the nation at AAA, but downgraded its outlook to negative on November 28, 2011. But the S&P 500 started to fall on July 22 as investors grew impatient with Congress. The S&P 500 declined 16.5% from July 22 to August 19. Capital Economics, a leading independent macroeconomic research group, even warned that a shutdown "could trigger a recession in the third or fourth quarter."

The nation's current debt is $19.9 trillion, and there are three Fed meetings before October 1. Assuming the Fed raises rates two more times, as it said it may do, a 12-month treasury may yield 1.65% by the end of this year and 2.15% by the end of next year. If the debt rises by $1 trillion by October, that means the nation could owe $449.35 billion in just interest payments. Assuming it takes $1 trillion to fund the government from May-October (6 months), that means the government's operating cost minus interest payments is about $572.15 billion over 6 months. Assuming a 2% inflation rate, Congress needs to pass a $1.03 trillion 6-month spending bill in October. U.S. debt to GDP is currently at 104.17%, and if the debt to GDP keeps rising about 2% a year, it will take about 8.8 years to reach the all-time high debt to GDP level of 121.7%. Italy and Portugal are not too far ahead at 132% and 130% respectively.

Source: U.S. debt to GDP 1940-2017

Conclusion:

Ignoring any geopolitical conflict or economic crisis from abroad, which range from North Korea to Greece and Italy, the economic and political situation at home does not seem strong enough to support the stock market much longer. As I mentioned before, I would recommend buying gold (NYSEARCA:GLD) to hedge against any such decline. But I also think accumulating cash to buy stocks at the bottom is a good strategy.

Source: Stockcharts.com

Checking on gold, the metal formed a bullish rounded bottom with a target of $1,305/oz. in about 5-25 days, a rise of 1.95%. The W%R is very overbought, and the RSI is close to overbought.

Disclosure: I am/we are long SBGL, DRD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.