Don’t be Swayed by “Sell in May and Go Away!”

Are you a trader or an investor? Ask Warren Buffett, the greatest investor of our lifetime, why he believes in buying and holding as do we unless there is a reason to change course as we did last October. We know many rich investors but few wealthy traders.

We understand the virtues of compounding and the negative impact of paying taxes on long term performance. Of course, always sell a stock if you believe that it’s fully valued. You may even consider writing covered calls or selling some market protection on a short-term basis if you are worried about near-term fundamental risks. We utilize both tools at times.

We are tired of hearing the pundits last week recommending taking profits just because we were entering May only to moderate their views on Friday after the sensational labor report.

We have rarely seen an environment so conducive to risk taking:

  • The economy is expanding above trend
  • Unemployment is at 3.6%, a fifty-year low
  • Non-farm productivity increased 3.6% in the first quarter pulling unit labor costs below 0 despite accelerating wage gains;
  • Inflation is well below the 2% Fed threshold
  • The Fed is accommodative/on hold for a year
  • Bank liquidity and capital ratios are at all-time highs
  • Earnings/cash flow are better than expected
  • The market multiple is around 17 times prospective 2019 earnings with 10-year treasuries hovering around 2.5%
  • Prospects for trade deals look better and better.

Yes, we have had a meteoric gain this year, but we are only back to where we were a year ago. The market is fundamentally undervalued today so why sell, pay taxes and alter your holding period? Fund performance should be valued net of taxes as it is what is left in the bank after all that counts, not gross performance.

We fully recognize that markets can correct at any time without reason, but it rarely happens when everyone expects it to occur, like now. The simple truth is that this is one of the most unloved markets that we have ever seen with participants anxious to go home protecting gains made to date. The market has been bipolar running with the winners and punishing beyond reason any company that falters even if by a penny. Herein lies great opportunities for the investor with a multi-year time horizon.

While there is no place like home, we are also investing in China as the government has successfully navigated through a rough patch and appears to be negotiating in good faith with the U.S. to reach a trade deal soon. We are also getting more optimistic on Japan as it appears that we could reach a trade deal with them sooner than we initially thought. While we believe that these deals will be good for Europe and the Emerging Markets, we also find them with more risk than other markets if no trade deals are reached so we’d rather hold off for now.

Let’s look at the recent data points that support or detract from our current view:

  • There is very little bad that we could say about the recent data points in the United States: private payrolls surged by 263,000 jobs in April with average hourly earnings increasing 3.2% year over year vs 2.8% the prior month; worker productivity increased 3.6% in the first quarter; consumer spending rose 0.9% in March, the strongest gain in a decade; the PCE inflation index was flat in March and up only 1.6% year over year; factory orders rose a seasonally adjusted 1.9% in March with new orders, excluding transportation up 0.8%; pending home sales surged 3.8% in March although down 1.2% over the last year; and consumer confidence jumped to 129.2 in April with the present situation index at 168.3 and future expectations now up to 103, both decade highs.
  • However, the Manufacturers Supply Side index slipped to 52.7 in April while the ISM Services Index declined slightly to 55.5. Readings above 50 are considered expansionary.
  • The Fed held rates steady as expected continuing to pledge patience and data dependent on any future moves. Market participants got upset when Chairman Powell mentioned in the follow up news conference that he felt that low inflation was transitory and would return to higher levels down the road. It seems that Buffett agrees, questioning the consequences of a lack of fiscal constraint on future inflation. As you know, we have long held the opinion that future inflation would remain surprisingly low held down by global competition, major technological advancements, and the rise of disruptors in all sorts of industries.
  • Finally, comments from the administration support our view that trade deals with China and Japan are on the horizon. While we would not expect to see any immediate impact to global growth, it will favorably improve growth prospects in 2020 and 2021. The financial markets will anticipate the improvements in growth well before it happens. We expect U.S. agriculture to be major beneficiaries of any trade deals and have invested accordingly.
  • By the way, while Trump and the Democrats appear to have agreed on the framework for a $2 trillion-dollar infrastructure program, don’t expect one any time soon.

The bottom line is that the U.S. economy is on track to have another above trend year and could be even better next year, an election year, if trade deals are reached and passed in Congress.

  • We remain optimistic about the prospects for China this year and beyond, especially if trade deals are reached. The official manufacturers purchasing index fell slightly in April to 50.1 with some weakness reported in production and new orders too. All three readings remain above 50 signaling continued expansion. We continue to expect growth near 6.4% for the year boosted by accelerating fiscal spending, lower taxes and a sharp increase in the monetary aggregates. A trade deal, once reached, will do wonders for business/consumer sentiment and growth.
  • We were pleasantly surprised that first-quarter growth exceeded expectations in the Eurozone but don’t go wild as it was only 0.4% compared to the abysmal fourth quarter of 2018. Inflation was also higher than expected rising 1.2% in April excluding food and energy. Growth prospects in the region remain bleak until there is substantial fiscal, regulatory and trade policy changes to better compete globally.
  • Japan prospects rest entirely on trade deals being reached. It does look better than we earlier envisioned.

Let’s wrap this up.

Stay the course and don’t be swayed by the slogan “Sell in May and Go Away” as the fundamentals just don’t warrant it at all. Could there be a correction? Of course, but continue to look over the valley as the outlook remains positive for risk assets, especially here.

Our portfolios continue to evolve as opportunities to sell and buy pop up.  Our portfolios include some healthcare stocks that reached attractive buy points; technology including semis that we added to recently on this pullback; global capital goods and industrials; some agricultural stocks that should benefit from trade deals; low cost industrial commodity companies; housing related names like HD; large U.S. global banks like BAC and C; and many special situations. The common thread throughout out portfolios is excellent management, strong business plans to globally compete and win; strong financials with huge free cash flow; above market yields; and selling below intrinsic value. We are flat the dollar expecting it to weaken on trade deals and own no bonds expecting the yield curve to steepen as global growth improves over the next eighteen months.

Remember to review all the facts; pause, reflect and consider mindset shifts; always look at your asset mix and risk controls; do independent research and …

Invest Accordingly!

Bill Ehrman

Paix et Prospérité LLC


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