Dog Days of Summer

It certainly looks like the saying “Sell in May and Go Away” was a good call, just like it was a year ago.  Stocks fell for five consecutive weeks, but the total decline so far is only 6%, compared to 16% peak-to-trough drop last year.  At least for now, this is just a garden-variety pullback.

There was no dearth of  negative economic reports to justify this pullback.  Consider:

– The index of 20-city house prices fell below the level of 2009, which means that double-dip in housing market is here.

– Only 54,000 new jobs were created in May, much lower than expected.  The unemployment rate actually rose 0.1% to 9.1%.

– Manufacturing index fell to 53.4 (although a reading above 50 indicates growth)

– Consumer confidence index also fell, bringing it to the lowest level in 6 months.

– Leading investment banks, such as Goldman Sachs, lowered U.S. GDP forecasts.

As a result, investor sentiment turned decidedly bearish, which is quite a contrast to positive outlook just one month ago.  One might even wonder why the markets didn’t decline even more!

Despite the apparent slowdown, few economists believe that we are headed back to a recession; a new term — BBQ recovery — was even coined to describe the continuing recovery as low and slow.  The interest rates, as Fed Chairman Ben Bernanke stated on numerous occasions, will remain at current near-zero levels for an “extended period”.  Companies are using this opportunity to issue new debt at low interest rates to refinance their existing debt, buy back stock, or buy their competitors, all of which are long-term positives for the stock market.  In this interest rate environment, bonds are simply not competitive with stocks, and there are no other compelling alternatives to equities.

As we all know, company earnings ultimately drive the stock prices, and earning reports for a number of recent quarters were very strong.  So far, there were no negative pre-announcements; in fact, many companies reaffirmed their profit outlooks.  If Q2 earnings season shapes up similarly to several past quarters, this will help the markets to weather “dog days of summer”, consolidate and move forward.  The “Sell in May” crowd is correct so far, but in all likelihood they would have  missed a 30% gain from the low of correction last summer!