Stay in May: Week of 5/20/24

This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.

Seven & Seven

Springtime is for growth, and the vibe in the markets last week had “reflation” written all over it. As quickly as the S&P 500 fell 6%, it’s back at a new all-time high.? While the S&P 500 equal-weighted index has not made it back to the old highs, 80% of stocks are above their 200-day moving average, which is quite respectable.

The quick recovery is typical of bull markets, and we continue to track the soft-landing analogs of 1994, 2016, and 1966.? I guess I should call this the “Seven & Seven” market: a 7th inning cyclical bull within a 7th inning secular bull.

Earnings are Hot

The reflation narrative bodes well for earnings, which already have considerable momentum.? Trailing EPS are up 4% from a year ago, and the estimate for the next 12 months is at $251 and rising.? With Q1 earnings season mostly complete, the growth rate from a year ago is 7% (similar to Q4).

The Reflation Playbook: the Dollar, EM & Commodities

It’s been a while since we have seen the reflation playbook in action.? For those unfamiliar, it involves a monetary pivot, a weaker dollar, and a rally in risk assets led by commodities and EM equities. We had several episodes of this in the aftermath of the Global Financial Crisis (GFC), and they were typically sparked when the Fed capitulated on rate hikes or QT (quantitative tightening), while China was stimulating its economy.

The narrative is that the one-two punch of a softish jobs report and a more favorable CPI report gives the Fed some more room to execute on its easing bias.? That should narrow the interest rate differential between the US and the rest of the world, which lowers the dollar.

That allows those sectors and styles that were suffocating under the Fed’s restrictive monetary policy to finally breathe again.? EM equities are Exhibit A on that front.? Is a new bull market cycle finally born for EM?? There have been many false starts, but last week’s gains were impulsive and supported by strength in the CRB Raw Industrials index (bottom panel).? The chart below shows the MSCI EM index both including and excluding China.

Commodities are typically part of a reflation trade as well, and the price action here has been solid in recent weeks.

Bullish Broadening

Usually when EM rallies, it’s part of a broader US stock market rally.? Below we see the Russell 2000 index trying to form a large base.? At a P/E ratio of 15.3x, there’s plenty of value here, with the caveat that 31% of the index is non-profitable.

The Tortoise and the Hare

There has been much conversation lately about whether China has become un-investable and whether the baton has been passed to India.? At the helpful suggestion of a colleague to our north, I dusted off an old chart that I first created in 2000.? It shows the global S-curve by country, updated below through 2022. The x-axis shows the number of years of industrialization, and the y-axis shows per-capita GP.? The size of the bubble shows the working age population.

?Back in 1990, China and India were neck and neck and way at the bottom.? Now, China is ahead of the curve while India remains below it.? Could this be a story of the tortoise and the hare?? China’s demographics are becoming a challenge at a time when there has been a lot of capital misallocation.? Maybe the baton is being passed.? Of course, nothing in life is free, and it’s worth mentioning that China trades at 9 times earnings while India trades at 22x, but the chart suggests that a long period of mean reversion has begun.

Shiny Objects

Precious metals are part of the reflation playbook as well.? The recent rally in gold has been well documented, but less visible has been the explosive breakout in silver.? Silver is a combination of hard money and a play on improving economic activity.?

Gold has been no slouch though and appears to be betting on a new secular inflation regime.

Consolidations are Good, Especially for Bitcoin

And lest we forget that aspirational store of value called Bitcoin.? The price action continues to consolidate following the ETF-induced ramp earlier this year, as well as anticipation around the latest halving.? You can see it in the decline in open interest.? The futures market shows that there were plenty of “tourists” along for the ride when the spot products were finally launched in January.

Overall, Bitcoin is squarely in what I consider to be a fair value range, derived from a combination of historical adoption curves and real rates.

Revenge of the Nerds

With the Fed’s easing bias back in play, even the long-forgotten meme stocks made a brief comeback last week.? But emphasis on “brief.”

Dow 36k (+4k)

Meanwhile, that Dinosaur called the Dow Jones industrial Average just crossed the 40k mark for the first time.? Sometimes these milestones take forever to achieve, and other times they melt away quickly.

Mission Not Yet Accomplished

While last week’s favorable CPI report was a welcome relief after several straight months of hot reports, there is still a lot of wood to chop to recover from the 20% increase in consumer prices since the pandemic wreaked havoc on the world in 2020.? The chart below shows the CPI index during all economic expansions since 1871.? This has been one of the more inflationary expansions in history.?

A slowing rate of increase is cold comfort to a consumer still suffering from sticker shock.? Perhaps this is why consumer confidence is relatively weak given the economy’s strength, and why the typical rule of thumb of “it’s the economy, stupid” may not apply to this year’s election.

Presidential Cycle

Speaking of elections, the market continues to follow the election cycle closely, especially that iteration when the stock market is down in a mid-term year (pink line below).? By that measure, the market should continue to make strong gains this year.

Stay in May

It’s that time of year again, when the stock market’s strongest streak of returns tends to give way to a less robust seasonal pattern.?Does that mean we should Sell in May and Go Away??The rule of thumb (that it’s best to be out of the market from May through October) hasn’t worked in a decade, per the table below.? Here I show several iterations of the strategy (stocks vs cash, stocks vs bonds, S&P 500 vs utilities).?

Over the past five decades the rule has produced alpha, but it tends to work best during secular bear markets.? The next chart, which shows the performance as a scatter plot (the strategy’s return on the y-axis against the S&P 500 on the x-axis), highlights this.? Most of the alpha was generated just during the 2000’s (which produced both the bursting of the dot com bubble and the Global Financial Crisis).??

If we are in a cyclical bull market within a secular bull market, it’s probably better to Stay in May.? If we are in a Seven & Seven market, we want the compounding math to work for us as much as possible.

1134292.18.0