Secular bull update: Sell in May? Not this year
Don’t be fooled by this week’s flash report on first-quarter GDP. The 0.1% print, which likely will be revised up, clearly is an anomaly to what we believe is now happening in the economy. As a lot of other data suggested this week—manufacturing, pending home sales, consumer spending, loan growth and particularly this morning’s better-than-expected jump in April nonfarm payrolls, which put job growth at its highest level in more than two years—this recovery is accelerating. This is the point I want to emphasize today: there are good reasons to believe we are now headed for a period of stronger, prolonged growth that will start making this recovery feel and act more like a real expansion than the subpar one we’ve had so far. And with this acceleration should come the next phase of this secular bull, one we believe will push the S&P 500 to our target of 2,100 for this year and higher in subsequent years.
Currently, we are in an extended consolidation phase, which is not uncommon in secular bull markets that are in transition. As we’ve said before, we think the bull has been transitioning from Phase I, “The world is not ending after all” (2009 to 2013), to Phase II, “The return of growth” (2014 to 2016?). The return of growth has been obfuscated by the bleak winter, and the “New Normal’’ bears believe that the acceleration we are seeing (and have been expecting) is a one-off bounce from the bad weather. We think it’s much bigger than that, and expect continued economic acceleration into the summer and fall as the “Old Normal’’ starts to reassert itself (we never really bought into the “New Normal’’ paradigm). Once this begins to be reflected in corporate earnings, with the Federal Reserve continuing to remain supportive, we would expect equity markets to move higher. Let’s dive a little deeper:
- Most of the economic news has been good. On balance, the economic data coming through of late has been solid. Jobs numbers have shaken off the winter chill, inflation remains low, retail sales have surged post the December-January lull, auto sales are back above the 16 million annual run rate, and industrial production and factory orders are bouncing higher. Only new home sales have been weak, but this seems more due to weather (temporary) and/or strong pricing (rising prices really is a positive.) With supply and demand tight and pricing strong, we expect housing and non-residential construction to accelerate later this spring and summer. For the bears who are hoping for a recession, I would note that virtually all of the indicators historically indicative of a recession—an inverted yield curve, rising interest rates, low unemployment rates, etc.—are simply not in place. This expansion has been weak so far, but the good news is it has a long way to go.
- The earnings news has been positive. The bulk of S&P companies that have reported so far are beating reduced earnings expectations, and importantly, are guiding higher for the full year. We see our $120 above-consensus earnings estimate on the S&P as very much intact. At this earnings level, the market is inexpensive at only 15.5 times forward earnings. And versus bonds, this level is ridiculously cheap.
- Animal spirits are back. I think the real news the last few weeks has been an acceleration in corporate M&A activity, consistent with our idea that animal spirits are finally returning to the economy. We also like what’s going on in bank lending, which has finally picked up after nearly six years in reverse—commercial & industrial loan growth accelerated at a 22% annual rate the past 13 weeks. We think bank lending is the equivalent of a lighted match on a pile of dry tinder. It will light up the economy and only improve the positive trend in investments and capital expenditures.
- Central banks remain supportive. In her recent speech in New York, Fed Chair Janet Yellen made it clear she is going to hold the line on interest rates for a good while, and would rather risk inflation to deflation to be sure this “structurally weak” economy gets airborne. The European Central Bank and the Bank of Japan are even more accommodating. This is creating a goldilocks scenario for markets.
- Sentiment leans long-term bearish. Despite all of the above, my read on investors (both retail and institutional) is that the bulls are nervous and the bears confident. The “New Normal’’ mavens continue to get a lot of attention as the scars of 2008-09 are still fresh. This is the wall of worry we need to climb higher.
For all these reasons, we remain overweight equities. While the market could suffer another pullback, we think the lows during this latest consolidation period have been reached, and continue to lean in favor of cyclical stocks (industrials, construction, financials, materials, and consumer discretionary). Unlike the past few years, when “Sell in May and Go Away’’ pretty much held to form, we think it would be mistake to act in such a way this year, particularly given the major indices have been essentially flat year-to-date and the economic data is strengthening into summer, not a slowing. Stay the course, and use dips to average in at more attractive prices.