by Brooke Thackray, Alphamountain Investments
Enjoy the stock market rally while it lasts!
The stock markets have enjoyed a “Trump bump.” Despite a recent “Trump fade,” North American stock markets are positive for the year and economic numbers have been fairly solid. Stock market volatility is low and recently the S&P 500® experienced a 110-day run without a 1% correction. Everything just feels good. Enjoy it while it lasts.
It is not that there are ominous clouds on the horizon. There is nothing out there pointing to a sudden correction, but that does not mean that the stock market cannot correct. It can correct at any time. When everything seems just right, it is the surprises that can re-direct the stock market downwards. A healthy stock market tends
to absorb the negative surprises well, with only a minor correction before heading higher once again. Or even, interpreting a typically negative event, with a positive spin. This is the type of market that we have been experiencing.
So, if we have been in a good market, what is the worry? There are signs that the winds are shifting. Investors are starting to fade the “Trump sectors.” In other words, the sectors that outperformed after the U.S. election, are starting to show signs of fatigue and even underperforming.
One of the major beneficiaries of Trump being elected was the financial sector. Since mid-December, it has had lumpy performance, but overall it has underperformed the S&P 500®. This is key. If a major sector, such as the financial sector that is often considered a barometer of the stock market, underperforms in its seasonal period, investors should start to get concerned. If the financial sector underperforms heading into their earnings releases in mid-April and continues to underperform after the bank earnings start to be released, then this will be a significant sign that the market is at least looking to pause or even correct.
If the bank earnings are better than expected, watch the sector’s relative performance compared to the S&P 500®. As long as the financial sector is outperforming the S&P 500®, it will probably indicate that stock market is healthy. If it starts to underperform, then this will once again be a significant sign that the stock market is at least looking to pause or even correct.
The financial sector is a bellwether of the overall stock market. Generally, if the financial sector is outperforming the S&P 500® and is one of the top sectors, the stock market tends to have a sustainable rally. The inverse is not necessarily true, but from a seasonal basis, if a major sector such as the financial sector cannot lead the market higher in its seasonal period, then this is not a good thing.
Other “Trump sectors” such as the industrials and small caps have also not been outperforming the S&P 500®. It is possible that the sectors could once again lead, but the small cap sector is no longer in its seasonal period and the industrial sector has a few weeks left in its seasonal period. The point is that what was once leading is no longer leading. The winds are shifting and when the wind shifts change occurs.
The bigger implication for the change that is taking place is that we are less than one month away from the six- month favorable exit date. Typically, in early May, from a seasonal basis it is best to start to become more conservative.
Traditionally, most market analysts and academics, consider the start of the six-month seasonal period to begin May 1st. Academics love to start and end trading cycles at month end. This calendar straight jacket can miss intra month trends, such as the average difference in performance between the first half of April and the second half. The first half of April has traditional been strong. The main factor causing the first half of April to be stronger than the second half is that April is an earnings month. All of the earnings months, January, April, July and October, historically have had strong first halves, as investors anticipate a positive benefit leading in to earnings season. In my Thackray’s 2017 Investor’s Guide, page 43, I outline this phenomenon and title the strategy, 18 Day Earnings Month Effect. Although I refer to the first half of earnings months being seasonally, to put it more accurately, on average it is the first eighteen calendar days that are seasonally strong. On average, the last part of April (19th to the 30th) tends to be much weaker than the first part of the month.
So, where does that leave us at this time. The stock market is once again showing some weakness, when it typically tends to be positive and the upcoming last part of April tends to be less than stellar. In other words, maybe the stock market doesn’t make it to May 5th, before correcting. Of course, the stock market can correct before May 5th or after May 5th, or even continue to rally for many months. On a seasonal basis, May 5th has been a good average date to exit the stock market, but in the past the stock market has also corrected earlier. It is possible that this could be one of those years. Investors should be cautious in the stock market at this time and be prepared to adjust their portfolios accordingly, especially since the six-month unfavorable period for stocks is just around the corner. Enjoy the stock market rally while it lasts!
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