INSIGHTS

On April 29, 2013

May Day for the Markets…Potentially Not?

As we approach May 1, aka May Day for the bearish pundits, we begin the process of seeing the “Sell in May” crowd show up.  This phenomenon, which we wrote about last year, has had a more convincing run over the last several years and has seemed to become a self-fulfilling prophecy.  In fact, according to Credit Suisse, the economic pattern has had a very pronounced six-month cycle which corresponds closely with the markets.  As any market observer or investor will tell you, the summer slowdown has some substance to it but has been a bit more amplified by the stories coming from Europe over the last several years. 

So as we approach the deadline for the “crowd trade,” many should be questioning where this selling might be coming from.  As we noted in the past, there are just under 3,565 total companies in the Wilshire 5000 which have a 90% weighting toward the large cap.  In recent headlines, we also have multiple Leveraged Buyout situations which remove companies from public trading as well.  With lackluster Initial Public Offering (IPO) markets, we are beginning to see a trend of pressure on the amount of stock traded.  This may be an early and subtle inference, but at a time when liquidity is growing among investors, even slight growth may not match the potential demand for equity assets. 

We continue to see a preponderance of calls for corrections over the summer, and we could understand this sentiment.  At a time when the markets are hitting all-time highs, apprehension for investors who are avoiding the markets because of an abundance of anxiety riddled headlines, and a recent history of subtle corrections during the summer, many are willing to wait for a better entry point. 

A potential kink in this cyclical call is the increased amount of stock repurchases made on an aggregate level.  According to FactSet, in 2012 there was $384 billion worth of shares repurchased which amounted to “79.1% of free cash flow.”  This percentage was the largest amount of free cash flow since 2008.  With cash increasing on the corporate level, it seems a bit of a purgatory environment may be presenting itself for the multitude of institutional and retail investors.  The more the markets continue to climb, the more anxiety there is about putting excess cash to work.  If the markets correct, will most investors hold off in anticipation of a larger correction? 

For most investors, removing the emotional aspect of timing the market looks to be the best remedy. This might occur through a systematic and methodical approach for long-term investing.  Choosing a quarterly or semiannual approach to putting cash to work in sectors where insider buying, discounted market metrics like price-to-earnings and cash flow multiples, as well as targeting large dividend paying companies, has been a long-term successful strategy in our opinion.   Stock buybacks have always been a good short-term indication, though we would like to see more intrinsic investments over the long haul.

May 1^st is celebrated as International Workers’ Day in over 80 countries according to Laphams Quarterly.  With that in mind and the unemployment data being released this Friday, it might be important to see what is happening with the employment situation.  There are several undercurrents that continue to point to an improving employment picture:

• The average hours worked weekly currently stands at 34.6 hours which is above the average from the last eight years of 34.3 hours.  We continue to see companies willing to pay overtime to maintain flexibility should new orders drop rather than make the investment in new employees.  This has been the case for some time and will eventually see some diminishing productivity gains forcing a slight increase in hiring.
  
  
• This is corroborated in the average overtime hours worked in both the service and manufacturing side, on an aggregate measurement.
  
  
• The duration of unemployment has begun to rollover, even in spite of two recent increases over February and March.  Currently it stands at 37.1 weeks, though it has dropped from the high of 40.7 set in November 2011.
  
  
• Lastly, in an article titled “Real Culprit Behind Smaller Workforce: Age” by Ben Casselman from the Wall Street Journal, Mr. Casselman points out that the participation rate has been falling for some time, before the beginning of the last recession.  He points out that while we have an increasing amount of retiring workers, many in the youth profile are actually full time students.  He doesn’t state that this addresses the entire participation rate dilemma, but it does offer a more clear view of what the unemployment rate might actually be.

There will be some soft economic metrics as well negative headlines coming from Europe and China.  As such, we will begin to see more stress on the quantitative easing from the Federal Reserve and fears of a double dip, though we are not sure a double dip actually counts since the end of the recession occurred nearly 3 ½ years ago.  However, in taking the preponderance of the evidence of liquidity, growing earnings, increased positive development on corporate and household balance sheets and the overwhelming negative sentiment indicators, we continue to see long term opportunity in the equity markets.  Some of the best values for long term investors may actually reside in China, various emerging markets in Asia and Latin America as well as the value plays in Europe as well as certain growth sectors here domestically.  As we will begin to see the slowing headlines of the economy and concern for the market multiples which do not seem overvalued in our opinion, we would use any sell off as a point to add to long term equity holdings. 

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