Friday, August 22, 2014 - Be Careful Out There

Financial Review with Sinclair Noe

DOW – 38 = 17,001
SPX – 3 = 1988
NAS + 6 = 4538
10 YR YLD un = 2.40%
OIL - .46 = 93.50
GOLD + 4.30 = 1281.60
SILV un = 19.51

All three major indices posted gains for the week, with the Dow up 2%, the S&P up 1.7% and the Nasdaq up 1.6%. It was the strongest week of gains for both the Dow and the S&P since April, and the third straight week of gains for all three indices.

There is a lot to cover before we can wrap up the week. First we go to Jackson Hole Wyoming, where the Fed has been having a friendly get together of economists. Janet Yellen kicked off the event with a speech this morning. She said what you might expect: "There is no simple recipe for appropriate policy," and she called for a "pragmatic" approach that gives officials room to evaluate data as it arrives without committing to a preset policy path. And she backed up her comments with a new tool, the Labor Market Conditions Index, which measures 19 labor market indicators, and it isn’t new data, just combining it all together, but it showed she is monitoring the data.

Yellen referenced the possibility that labor markets may be a bit tighter than they seem and that the Fed may consider having to raise interest rates sooner than expected. At the last FOMC meeting in July, the Fed was still saying there was “significant” slack in the labor market, and today she confirmed that slack remains, saying: “Five years after the end of the recession, the labor market has yet to fully recover.” Another area of slack is wage deflation. Employers cut some wages during the downturn, or eliminated raises, and they aren’t offering raises now. Yellen said: “wages could begin to rise at a noticeably more rapid pace once pent-up wage deflation has been absorbed.”

So, today Yellen didn’t say anything radically different, just a hint less dovish, or at least not as dovish as Wall Street might have hoped for.  

Just in case you were wondering, there have been some protestors at Jackson Hole; one group could be spotted wearing T-shirts printed with graphs showing wage inequality; apparently, an attorney representing the protestors got to talk with Yellen for a minute or two. Meanwhile, investment bankers were noticeably absent from this year’s symposium; the invitation list is mostly devoid of representatives from big private-sector banks. The Fed finally figured out that rubbing elbows and special access wreaks of cronyism.

The Jackson Hole Symposium featured more than Yellen. There was a variety of papers on multiple subjects. A professor from MIT presented a paper detailing how robots and computers don’t steal as many jobs as you might think. Seems the robots are not good at jobs requiring judgment and common sense. So we aren’t obsolete just yet.

Another bit of research says we are less likely to switch jobs, or there is less labor market fluidity, and the reasons are that the workforce is getting older, and there is a shift to older businesses, which means fewer startups, and more startups tend to fail, and more jobs require occupational licensing or certification.

Yet another research paper concluded that the problem of long term unemployment is not necessarily terminal. The thinking has been that if someone loses a job and is out of work for a long time they have a harder time finding work, and eventually they lose their skills and fall out of the labor pool; the idea is called hysteresis, or the idea that cyclical unemployment becomes structural. The new research says it is only a moderate problem. So, the good news is that we are not obsolete and we are adaptable.  

And then European Central Bank President Mario Draghi delivered a speech following lunch. Draghi said European central bankers and politicians each have a role to play in boosting demand and reducing joblessness. For its part the ECB is willing to take more stimulus measures if needed to keep low rates of inflation from becoming embedded in expectations of future price growth but the ECB can't do it alone and governments must join in efforts to reduce unemployment.

For Draghi, this was a bigger shift in policy; for years the ECB has been preaching that governments needed to shrink deficits and undertake economic reforms even during times of economic weakness. The austerity measures did not work; the result has been stubbornly high unemployment, stagnation, and disinflation or low-flation bordering on deflation, with a dollop of double dip recession.

Draghi admitted as much, saying the GDP data "confirm that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lackluster demand." And so Draghi called on combining monetary and fiscal policies to stimulate demand with efforts to make labor markets more flexible. He also proposed a significant boost in public investment.

In June, the ECB approved a stimulus package that includes record low interest rates, new 4-year loans to banks, and a step toward large scale purchases of asset backed securities, although no new QE announcement was forthcoming in today’s speech. Draghi said today: "The risks of 'doing too little'" and allowing temporary unemployment to become more entrenched "outweigh those of 'doing too much’, that is, excessive upward wage and price pressures."

So, while Draghi firmly planted an anti-austerity flag, he also felt the ECB’s June stimulus will be all that they can do, and he recognizes the real risk that monetary policy loses effectiveness, and somebody needs to wake up the government.

There is a long tradition of the Jackson Hole symposium giving a little bump to the markets; not today, and the reason had less to do with the doves and hawks on the Fed and more to do with geopolitics.

Ukraine says Russian artillery is being used against Ukraine's forces, both from across the border and from inside Ukraine. In addition, NATO said it has seen "transfers of large quantities of advanced weapons, including tanks, armored personnel carriers and artillery, to separatists." Moscow sent more than 130 trucks rolling across the border in what it said was a mission to deliver humanitarian aid. Ukraine called it a "direct invasion," and the US and NATO condemned it as well.

The trucks, part of a convoy of 260 vehicles, entered Ukraine without government permission after being held up at the border for a week amid fears the mission was a Kremlin ploy to help the pro-Russian separatists in eastern Ukraine. Russia claims the trucks are carrying food, water, and other humanitarian supplies. The city of Luhansk has been largely cut off for weeks and is without water and electricity as Ukraine forces fight rebels. Ukraine wanted the international Red Cross to inspect all trucks, fearful of a Trojan horse; but Russia lost patience and accused Ukraine of stalling. The Red Cross, which had planned to escort the convoy to assuage fears that it was a cover for a Russian invasion, said it had not received enough security guarantees to do so, as shelling had continued overnight.

Ukraine said they would not shell the convoy but rebel forces took advantage of that promise to drive on the roads being used by the convoy.

Meanwhile, Hamas-led gunmen in Gaza executed 18 Palestinians accused of collaborating with Israel. The executions were held in a public square. I suppose that has a certain deterrent effect. The ceasefire, like others before it, did not last long. Israeli Prime Minister Benjamin Netanyahu threatened to escalate the fight against Hamas after a four-year-old Israeli boy was killed by a mortar attack from Gaza. Shortly after his remarks, Palestinian officials said Israel had flattened a house in a Gaza City air strike, wounding at least 40 people. More than 80 rockets and mortars shot from Gaza hit Israel. Israeli forces carried out more than 25 air strikes in Gaza. Since the conflict began last month, 2,071 Palestinians, many of them civilians, have now been killed and around 400,000 of the enclave's 1.8 million people displaced. Sixty-four Israeli soldiers and four civilians in Israel have been killed.

Meanwhile, the quagmire in Iraq is sucking us in ever deeper. You will recall that just 2 weeks ago, President Obama announced “targeted airstrikes to protect our American personnel and a humanitarian effort to help save thousands of Iraqi civilians who are trapped on a mountain without food and water and facing almost certain death.” And it seemed to work, sort of. The Yazidis trapped on the mountain got off the mountain, most of them anyway.

And then there was the problem of ISIS controlling the Mosul Dam, and the threat of using the dam to flood the Tigris River valley, and that includes Baghdad; so there was some extra work to do there. And then there was the horrific beheading of American journalist James Foley, and yesterday Secretary of Defense Chuck Hagel called ISIS an “imminent threat to every interest we have,” while Chairman of the Joint Chiefs of Staff General Martin Dempsey conceded that attacks on ISIS could not be limited to Iraq but would also spread into Syria; and Secretary of State John Kerry said ISIS “must be destroyed and will be crushed”.

And now Iraq has a new prime minister, Haider al-Abadi. The hope was that he could forge a new coalition government. Not exactly. Sunni lawmakers quit talks on forming a new Iraqi government after gunmen killed scores of worshipers at a Sunni mosque in a province neighboring Baghdad. Today’s strike took place after three roadside bombs targeted a Shiite political gathering.

Federal authorities today urged law enforcement across the country to be alert for possible attacks inside the United States in retaliation for US airstrikes against ISIS. In a joint bulletin issued to local, state and federal law enforcement, the Department of Homeland Security and FBI said that while they are “unaware of any specific, credible threats against the Homeland” and find most threats to the U.S. homeland by supporters of ISIS “not credible,” they cannot rule out attacks in the United States from sympathizers radicalized by the group’s online propaganda.

Be careful out there.

Retailers have taken a recent hit, with weak earnings reports from the likes of Wal-Mart and Sears. Today Ross Stores posted better than expected second quarter results. The S&P Retail Index gained 0.6%, which doesn’t sound like much but it was the best week since February. The heavy promotional environment has been forcing retailers to offer discounts to stay relevant even as they deal with the growing shift to online sales. The big brick-and-mortar retailers have been trying to adjust to this shifting landscape. The labor market is no doubt improving, but wage growth has been essentially stagnant, restricting households’ buying power. In a nutshell, it has been a tough backdrop for retailers. No doubt the stock-price performance of the retail sector in the S&P 500 has been one of the weakest in the index – up +0.9% vs. a gain of +8.6% for the index as a whole.

Total earnings for the 490 S&P 500 members that have reported already are up +8.1% from the same period last year, with a ‘beat ratio’ of 65.5% and a median surprise of +2.6%. Total revenues are up +4.4%, with a very impressive revenue ‘beat ratio’ of 62.2% and a median surprise of 0.8%. So, this has been a strong earnings season, with the minor exception that guidance has been a little less than satisfying.

Stock prices of small-cap stocks have been underwater this year, with the S&P 600 down -1.2% vs. a gain of +8.6% for the S&P 500 in the year-to-date period. This underwhelming stock price performance is getting confirmed by the group’s mixed results thus far in the Q2 reporting cycle. As of Friday, August 22, we have seen Q2 results from 555 S&P 600 members or 92.5% of the index’s total members. Total earnings for these 555 companies are up +12.1% from the same period last year on +9.5% higher revenues, with 48.6% beating EPS estimates and 38.2% coming ahead of top-line expectations. 

Total earnings in Q2 are on track to reach a new all-time quarterly record, surpassing the last record set in 2013 Q4. That brings a good news/bad news conundrum. Is it just a one-time bounce of the low levels of the first quarter? It’s always difficult to top a record.

The S&P 500 is trading at 18.5x forward earnings, above the historical average of about 16.5x. The Shiller cyclically adjusted P/E ratio is currently about 26x the historical average of 16x. No matter how you manipulate the numbers, stock valuations are closer to the high end than the low end, and then the question is whether those valuations are justified in view of the risks facing stocks.

The biggest risk to stocks is the Fed ending its unprecedented experiment in easy money. Stock market investors have benefitted from ZIRP, zero interest rate policy, far longer than anyone might have imagined, and maybe Draghi was right when he talked today about the risk that monetary policy can lose its effectiveness. Now, maybe the Fed can exit QE and ZIRP and the markets will achieve liftoff; I just don’t know where we’ll find the fuel for liftoff.

The second most significant risk is the geopolitical havoc occurring around the world. And most of that havoc seems to be in or near areas with oil. From the heady days of mid-2008 when it traded at nearly $150 a barrel, crude oil has had quite a rocky ride. After sliding down to the $30s and rallying back around $120, crude has settled in around the $90 to $110 range for the past two years.  Commodity traders have wondered why oil hasn’t gone higher. Geopolitical tensions abound across the world; the Middle East seemingly hasn’t been this unstable in years. There may be reasons why oil prices have moved lower, including the renaissance in oil and gas exploration and development in the US; lower demand brought about by great efficiencies and conservation; also, the big investment banks have exited the oil  trading business and the oil  marketing business, and they have not been replaced by new players. A dip in oil prices could send some smaller exploration companies to the mat. A spike in oil prices could send stock investors to the exits. Geopolitical stability is decidedly bad for stocks, particularly stocks that are trading at very high valuations.

A third risk to stocks is that earnings will not keep pace. Corporations may have squeezed about all of the cost savings they can out of their businesses. While companies continue to "beat" expectations, the truth is that they are more leveraged than they were in 2007 on the cusp of the financial crisis, and they live in fear that interest rates are going to rise and they will not be able to service their debt. Meanwhile, consumers tend to hold onto a dollar until the eagle grins.

And then there is always the possibility of a black swan event, which could pop up almost anywhere, including the financial markets where big banks are bigger than ever, and money markets are now poised to close their vaults rather than risk a run, which is  just the sort of thing that creates a run; or maybe it will be a geopolitical mis-step – a bomb that lands in the wrong place, or a crazy Russian who turns off the nat gas spigot for the Eurozone.

An expensive market is always vulnerable to bad news and sell-offs. And so it is now more important than ever to be diligent, and don’t be afraid to lock in the hard won gains of the past 5 years.

Monday, August 18, 2014 - Theory and Instinct; Nobody Knows

Financial Review with Sinclair Noe

DOW + 175 = 16,838
SPX + 16 = 1971
NAS + 43 = 4508
10 YR YLD + .04 = 2.42%
OIL - .71 = 96.64
GOLD – 7.30 = 1297.20
SILV + .04 = 19.68

Over the weekend, the geopolitical hotspots did not explode. Kurdish forces made progress against ISIS militants in Iraq; Ukrainian forces made progress against pro-Russian separatists in eastern Ukraine. The ceasefire between Israel and Hamas is holding.

In economic news, the NAHB/Wells Fargo Housing Market Index showed that homebuilder sentiment rose for the third straight month in August. That should be a positive for new home construction.

Meanwhile, mortgage-finance giant Fannie Mae cut its outlook for the housing market this year and next, because rising mortgage rates, bad winter weather and consumer “conservatism” are all hitting the housing market. In its August forecast, Fannie said it expects construction starts for single-family homes to hit 642,000 in 2014, down about 8% from its July forecast of 696,000. Likewise, Fannie cuts its outlook for new single-family homes sales in 2014 by 11% to 431,000 from 486,000.

Housing affordability hit its lowest level in nearly six years in June. The National Association of Realtors reports the mortgage payment for a median-priced US home in June requires 16.3% of median household income. Even though housing affordability is still historically quite favorable by the NAR’s index, homes are not only becoming less affordable, but affordability may be even less favorable for first-time buyers. A separate index maintained by Goldman Sachs that looks only at marginal buyers shows that housing affordability is largely in line with its historic average.

The New York Federal Reserve says a new SEC rule designed to reduce runs on the money market mutual fund industry could create runs instead. At issue is part of the new SEC rule giving funds the ability to limit outflows by restricting redemptions when liquidity runs short. New York Fed economists say: “The possibility of a fee or any other measure that is costly enough to counter investors’ strong incentives to run amid a crisis will give investors a strong incentive to run preemptively to avoid such measures.”

It is Monday, and so there was some M&A activity. Dollar General made an $8.9 billion dollar, all cash bid for Family Dollar Stores. You will recall that Dollar Tree recently made a bid for Family Dollar, which works out to $74.50 a share, while today’s bid by Dollar General works out to $78.50 a share, and it’s cash.

So, for the most part, it was a typical Monday. But we are in the Dog Days of summer, and in these seemingly quiet, low volume, illiquid sessions we can see a small move quickly turn into a bigger move; a leisurely stroll turns into a gallop, turns into a stampede. The Fed 's Jackson Hole, Wyoming, symposium at the end of the week is also expected to send a dovish message to stocks, with employment and inflation nearing Fed goals, Fed Chair Janet Yellen has consistently cautioned some labor market measures still show enough slack to warrant keeping interest rates low. Heading into this year’s Jackson Hole assembly, the labor market is giving off mixed signals even as unemployment falls. About 28 percent of all part-time workers in July reported that slack business conditions or a dearth of full-time jobs kept them from finding full-time work. That’s up from a 19 percent share at the start of the downturn.

Most people are saving next to nothing, while just a few are saving a significant amount. Those who do save are saving a lot, more than $1.2 trillion a year. According to the Fed’s financial accounts data and definitions, the personal savings rate has averaged about 10% of disposable income since the recession ended, up from around 7% before the recession. That means upper-middle class and wealthy Americans are saving nearly $400 billion more a year than they used to. The Fed has been keeping interest rates low, and part of the thinking is that it forces investors to chase yield, but Americans have nearly $11 trillion parked in cash, and bank accounts, and money market funds that pay next to zero. So, the Fed might keep rates low, until we’re all willing to gamble, at which point, rates rise, and we all lose our bets.

The high share of workers who are part time for economic reasons is one reason that the Labor Department’s broadest measure of unemployment remains far above its 8.8 percent pre-recession level. U6 unemployment, which includes involuntarily part time and discouraged job seekers in addition to the jobless, is 12.2 percent, or almost double the 6.2 percent level of the main unemployment rate. Both increased by 0.1 percentage point in July from five-year lows in June.

So, what is this market worth? Robert Shiller says the stock market is very expensive right now. Shiller is the Nobel Prize winning Yale professor who helped create the cyclically adjusted price earnings ratio, which takes average inflation adjusted earnings from the past ten years. In a New York Times article yesterday, Shiller noted that the ratio is now at 25, up from 23 a year ago, and well above the historical average of about 15. The ratio has only moved above 25 three time in the last 130 years; it happened in 1929, 1999, and 2007; and of course the markets crashed. Makes sense; to justify high valuations, earnings would need to rise significantly, or prices would need to fall.

A 5 year long rally in US stocks has taken valuations higher, leaving some investors anxious, but the CAPE is just one measure of value. The S&P 500 trailing 12 month PE is right around 17.5, which is just a little above the long-term average, but not out of line. And most estimate for the next 12 months put the forward PE multiple at about 15.

Still, the bull market is getting long in the tooth; it is now the fourth longest bull market; topped only by the bull runs ending in 1961, 2000, and 1929; and of course we know how those markets finished. The lack of a meaningful correction is a severe divergence from the norm. In the summer of 2012, stocks posted greater than a 10% pullback. Since that time, all corrections have been contained to single digits. History shows that other incidents of abnormally small corrections have preceded large corrections exceeding 20%. But it doesn’t mean a crash is imminent; the markets will eventually falter, but it could be a long, long time. Meanwhile, the Nasdaq Composite made it up to a 14 year high today. Which sounds bullish, but really means that the past 14 years were lost.

Maybe stocks will fall from here; maybe stocks will rise from here. I don’t know. Maybe the housing market will go up from here; maybe housing prices will drop. I don’t know. The yield on the 10 year Treasury note was up 4 basis points to 2.42%; nobody knows why. The price of oil dropped below $97 a barrel; apparently because the ISIS idiots did not blow up the Mosul Dam; apparently because we have built up a stockpile of oil while cutting back on demand; that could all change tomorrow.

George Soros is the biggest money making fund manager around. He’s the only hedge fund manager to have earned $40 billion in profits for his investors. George Soros just turned 84. In an article from the Irish Times they quoted his son, Robert Soros, on the success and brilliance of the co-founder of the Quantum Fund. Robert said: “you know [that] the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm and it’s this early warning sign.”

Soros has admitted to relying greatly on “animal instincts”, saying the onset of acute pain was often “a signal that there was something wrong in my portfolio”. His decisions, then, “are really made using a combination of theory and instinct”.

The economic recovery is underway, or not, depending on any expert opinion of the hour. The main stumbling block to recovery is uncertainty or not, again depending. As we wait for factories to begin operating at full capacity, investors are growing increasingly frustrated at more than half a decade of prudence, pushing chief executives to loosen the purse strings. Capital spending could increase as early indicators show that industrial companies are beginning to run at higher levels of capacity than has been the case over the last five years. When factories and the like are running at less capacity on the back of lower demand there is very low capital expenditure. In the aftermath of the financial crisis companies hunkered down and re-engineered their balance sheets, diverting funds from investment to pay off debt or stockpile cash. However, even since the recession ended and the economy has picked up, many have continued to hoard cash leading to growing calls from investors to deploy cash reserves, which earns low returns sitting on balance sheets.

It is now estimated that global firms are sitting on a stockpile of $7 trillion in cash. The world’s corporate giants are poised to tap into record cash reserves and possibly embark on a long-awaited spending spree, fuelling hopes of a massive boost to the global economic recovery.

The bulk of the cash is held by 5,100 of the world’s biggest companies, which had combined reserves – cash and short-term debt – of $5.7 trillion as of the end of 2013, according to Thomson Reuters Datastream. The cash pile total excludes financial companies such as banks and insurers, who are required by regulators to hire capital.

Corporate America dominates the pack with about $2 trillion at its disposal, led by a clutch of tech titans. Apple’s cash mountain of $140bn means it has more unspent capital than any other American company, followed by Microsoft with $83bn, and Google, which has built up $59bn of reserves.

So, investors are hollering for companies to spend their cash and deliver higher returns, because cash doesn’t pay much. There are three things the companies can do: buy other companies, return the money to shareholders, or spend the money on the business and try to grow the business organically. What will they do? Nobody knows.

Wednesday, April 30, 2014 - Record Highs in First Gear

Financial Review with Sinclair Noe

DOW + 45 = 16580.84 (record close)
SPX + 5 = 1883
NAS + 11 = 4114
10 YR YLD - .04 = 2.65%
OIL – 1.59 = 99.69
GOLD – 4.60 = 1292.30
SILV - .29 = 19.25

Back on December 31^st, we finished the old year with a record high close on the Dow Industrial Average at 16,576; since then the index has bobbed up  and down, briefly hitting an intraday high of  16,631 on April 4^th, but on that day we finished in negative territory. Today, a record high close. The S&P 500 is closing in on the record high close of 1890, but not today.

Now, when you hear the Dow is breaking records, you might think the economy is roaring, cruising along the highway in fifth gear. You would be wrong; the economy is stuck in first gear and the clutch is slipping. The Commerce Department reports the economy expanded at a mere 0.1% annual pace in the first three months of the year, one of the weakest rates of growth in the nearly 5-year-old recovery.

A slowdown had been expected due to the harsh winter weather that froze business activity across a large swath of the country, but this report was worse than expected. The gross domestic product had been expanding at a 3.4% pace in the second half of last year. No worries, the weather has warmed and everything is returning to normal. Yeah, not exactly.

There has been a rebound in the monthly data for March but there have been some disappointments as well. On the positive side, households have pared down some of their debt, credit is a little more available, and consumer spending should bounce back. Even the 2% growth in consumption spending is not all that encouraging; 1.1% of that consumption growth, more than half, was attributed to higher household expenditures on health care.

Home construction is likely to pick up speed as the weather improves, but the housing market seems to be slowing down, with reports this week on new home sales turning soft and existing home sales turning negative in many areas. Residential investment has been negative for 2 quarters. The housing market probably won’t deliver much horsepower as the engine of economic growth but it should be a little better than the winter months, when many parts of the nation were frozen.

An area of concern is business investment, as company spending on equipment fell in the first quarter, and the 3 quarter average is barely positive. The change in inventories subtracted 0.57 percentage points from growth in Q1, exports subtracted 0.83 percentage points. The outlook for trade is soft; the US is not immune to weakness overseas; China’s economy has slowed; there are problems in the Eurozone; and emerging markets are still struggling. Meanwhile, incomes have flat lined and unemployment remains unpleasantly high.

On Friday we’ll get the monthly jobs report. Today, we got a preview from ADP, the human resources firm, and their data shows the economy added 210,000 jobs in April. The ADP report showed hiring picking up in nearly all industries and company sizes; it just isn’t picking up at a real fast pace.

The Federal Reserve FOMC wrapping up their policy meeting and they issued a statement that they will keep policy on the same track; interest rate targets are unchanged and the taper continues with another $10 billion in large scale asset purchases cut this month, to a mere $45 billion a month. The central bankers said that economic activity “slowed sharply” earlier in the year but noted it has “picked up recently.” And “The committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.”

The disappointing reading on economic growth earlier in the day underscored how bumpy the road back to normal can be. The FOMC statement repeated language from its last meeting in March stating that it will consider the country’s realized and expected progress toward full employment and 2% inflation in determining when to increase rates. The Fed also reiterated that it will take into account “a wide range of information,” including the health of the labor market, inflation pressures and financial developments. In some ways, you could look at the continuation of the taper as a vote of confidence from the Fed. Fed policymakers have said that the phaseout of bond purchases is not on autopilot; the Fed can speed it up or slow it down, depending on how the economy progresses, but apparently the weak GDP number today was not convincing enough to alter expectations; or maybe GDP falls outside the Fed mandate of price stability and maximum employment, and maybe it isn’t something they should specifically pinpoint. Of course, if the economy turns south, they will have to deal with it.

Many Americans are still wondering when the recovery is going to start, but by economic measures, the economy stopped shrinking and started growing in June 2009, the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker. And today’s GDP number was right on the edge of recessionary. The cold weather excuse only goes so far. Already in the second quarter we’ve had deadly and damaging tornadoes, and as the weather continues to warm, we’ll deal with the effects of drought. You have to wonder if the economy was plagued by more than just weather last quarter.

That doesn’t mean we are now entering a recession; we may be close but we aren’t there yet, and we may still rebound, but this affords a good opportunity to think about how you might handle the next downturn in the business cycle. The stock market was up today, and in light of the GDP report, you have to wonder about stock valuations; the earnings reports haven’t afforded much to cheer. Are you still buying or are you looking to sell into strength.

Since Q4 2011, the average peak-to-trough pull-back on the Dow has been roughly -6%, with no correction exceeding -10%. One may ascertain that a "buy-on-the-dip" mentality remains pervasive among equity investors. So why not add to long, risk-on positions once again? Could this pull-back be different? Aren't stocks "the only game in town" with the excessively accommodative Fed monetary policy?

And while you consider market risk, don’t forget the old idea of the best and worst six months in the stock market; we’re entering the worst six months by the way. The old adage "Sell in May and Go Away", warning investors of a seasonal decline in equities, is often attributed to summer vacations and decreased investment flows relative to winter months. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. 

When we look at the 13 cases since 2001, the strategy of selling out just before May would have given rise to successful trades in 9 cases, or about 70 % of the time. Moreover, we observe that the "Sell in May" strategy has not failed in two consecutive years since 1992-1993. Given that "Sell in May" failed in 2013, we estimate the odds for a seasonal decline are even higher for 2014. This is not a perfect indicator, but there are not perfect indicators. You have to think that anybody who doesn’t recognize the odds is just trying to sell you something.

And on the question of valuations, at 18 times forward earnings for the S&P 500 and 36 times forward earnings for the Nasdaq, US stocks are generally closer to the high end of their range; that seems a bit pricey compared to emerging markets with 12 times forward earnings. Still, somebody was buying today, at least enough to push the Dow to a record high close. Investor optimism for US stocks has been trending up since the end of 2011, reaching an extreme level in January. Of course that would be a contrary indicator. There are plenty of voices telling you to stay the course, or even buy, and then buy some more. I’m just saying it is important to consider the possibility of selling into strength.