I Repeat: Don't Sell In May (Or Go Away)

By Gary Alexander

Looked at from 37,000 feet, this market is the essence of flatness – like Central Kansas in “fly-over” America. Last week, the S&P 500 fell by (hold your breath) 0.23 points. That’s less than 0.01%. Year-to-date (through Friday), the S&P is down 3.7 points, or 0.14%. For the month of April, the S&P is up 1.1%, which sounds like a gargantuan number compared to last week, but it’s still frustratingly small.

After March’s 2.7% decline and April’s tepid 1.1% gain, should we now compound our pain and “Sell in May and go away”? After all, “Sell in May” was a winning formula, historically, from 1950 to 2012.

WARNING: The following chart could be misleading. It is for historical informational purposes only!

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Past performance really does not indicate future performance. In fact, this chart is somewhat misleading.

Five years ago, I wrote the following headline in MarketMail (for April 29, 2013): “This Bull Market Has Legs: Don’t ‘Sell in May & Go Away.’” I guess I got lucky, since that the “Sell in May” formula stopped working that year forward. In the last five years, the S&P has gained an average 5.55% from May 1 to October 31 (the historically “bad” months), while it averaged only 5.15% from November 1 to April 30:

The “Sell in May” theory has another major flaw. If you sell, when do you plan to re-enter the market? July is the #2 month in the last 100 years (and August is #5), according to Bespoke Investment Group’s Seasonality studies. Do you really want to exit stocks for just two months? And here’s a shocker: October is suddenly the #1 best month over the last 20 years – since 1998 – up an average 2.5%!

This year, the “Sell in May” crowd has a new argument to muster, the “May Day” fear of the steel and aluminum tariffs taking effect in Europe and elsewhere (See Reuters: “Mayday on May Day: Trump Steel Tariff Deadline Looms”). The tariff exemptions for Europe and other allies run out today, May 1 – the traditional “worker’s holiday,” still observed in 100 nations. At press time, all sorts of concessions and trade-offs are being discussed. This is typical Trumpism – brinksmanship, followed by last-second deals.

The Federal Open Market Committee (FOMC) is also meeting May 1-2, which gives the bears some more reason to worry, but this is not one of those meetings followed by a press conference. The FOMC tends to save its rate-raising decisions for meetings followed by a press conference. The next such event is in June.

First-Quarter GDP Was Seen as Weak – But Was It?

The page 1 headline in the weekend Wall Street Journal said that first-quarter GDP came in at a “reduced pace” of 2.3% as “Consumers Cool U.S. Growth, but Business Thrives.” That was a pleasantly balanced headline, since earnings are up precisely 10 times faster than GDP growth in the first quarter. According to FactSet, with 53% of the S&P 500 companies having reported, the blended growth rate for Q1 EPS stands at +23.2%, more than double the 11.3% rate expected at the start of the quarter and the 17.1% growth expected as late as March 31. Almost 80% have reported positive earnings surprises – the highest number since FactSet began tracking this metric in 2008 – and 74% reported positive sales surprises.

How can this be – earnings at +23.2% vs. GDP at +2.3% in the same quarter? Part of it has to do with how GDP is reported. As pundits constantly remind us, the consumer represents about 70% of GDP, but the consumer does not represent 70% of the real economy, since GDP over-weights consumer activity.

In last Tuesday’s Wall Street Journal (“If GDP Lags, Watch the Economy GO”), economist Mark Skousen brought our attention once again to the fact that business-to-business activity is not reported adequately in GDP accounting. “Gross output,” or GO, he says, “reflects the full value of the supply chain—the business-to-business spending that moves all goods and services toward the final retail market. Based on my work and research by David Ranson, chief economist at HCWE & Co., changes in the supply chain are a strong leading indicator of the next quarter’s GDP. The supply chain, which the BEA calls ‘intermediate inputs,’ took off in the fourth quarter of 2017, growing at a 7.5% annualized rate. That’s more than double the rate of real GDP growth and the fastest pace since before the Great Recession. Real GO, which includes both GDP and the supply chain, rose at a 4.7% rate.”

This boom in intermediate activity, he says, “should translate into higher economic growth soon, barring international instability, trade wars, or tighter-than-expected monetary policy.” That’s because business activities dominate the 10 “leading economic indicators,” which tend to anticipate economic growth.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The latest uptick in “GO” (blue line) implies a rising GDP to follow; Source: MSkousen.com, April 19, 2018

Since last week’s GDP report was the first preliminary reading, a positive “GO” signals that future 1Q revisions and later quarters this year might escalate upward from 2.3%, perhaps reaching 3% and above.

Yes, consumption is 69% of GDP but it’s just 39% of GO. Business spending is only 17% of GDP but it’s 52% of GO. Obviously, GDP over-weights consumers, so it runs hot and cold on indicators like retail sales. When consumers make and save more money, GDP turns down, but that money does not disappear. It will be invested or spent later on, pushing up either the stock market (if invested) or GDP (if spent).

Larry Kudlow, the new director of the National Economic Council, once wrote: “It is business, not consumers, that is the heart of the economy. When businesses produce profitably, they create income-producing jobs and thus consumers spend. Capital formation is the key to worker productivity and consumer prosperity.” He was right then (2006), and he would be wise to whisper this into Trump’s ear.

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