There’s a popular stock market adage that says “Sell in May and go away,” due to the belief that the months of November-April have significantly stronger growth on average than the months of May-October. This May sure didn’t do anything to disprove that theory. The past month was arguably the worst the markets have seen in two years with losses over 6%.
May started with a disappointing non-farm payrolls report to cap the first week of the month. The important data points to take away from the report was that 41% of the unemployed have been unemployed for 39 weeks or more, and 80% of the drop in the unemployment numbers has to do with the drop in the labor force participation rate (the lowest since 1981). The labor force participation rate looks at the total employed people and unemployed still looking for work. A low participation rate (read as many unemployed people not being tracked by having exhausted benefits) is not a good thing. It is especially not a good thing for an economy that desperately needs growth.
The second week of May brought two familiar topics back into the news – Europe’s financial crisis and U.S. banks. Spain’s fourth largest bank, Bankia SA, was nationalized. Bankia SA was built over the years through mergers of local banks (Cajas). The Cajas are renowned for having large amounts of exposure to bad property loans. Through Spain’s property boom in the last 15 years, the Cajas were a major real estate financing point for Spaniards. In the last eight months, we have seen Belgium’s largest bank nationalized, over $1 trillion dollars pumped into the European banking system via the European Central Bank, and now Spain’s fourth largest bank being nationalized. The story in Greece and Europe is not over yet.
J.P. Morgan stormed into the news by holding a conference call to discuss some very large trading losses ($2 billion and growing). I have gone out of my way to avoid portfolio exposure to larger U.S. banks. This is the kind of news that validates my concern that the economic events during and since 2008 have made no impact on risks in the larger U.S. banks. The leverage in the banking system is at or worse than 2008. The big Wall Street banks are still making large bets that they are trying to pass off as “hedge” trades versus mere speculative bets. A hedge bet is where one tries to insure a real investment or interest. As an example, an airline “hedges” oil costs through the futures market. An investor may protect a stock holding through option investments. J.P. Morgan looks to have been making speculative bets with no investment or interest it was trying to protect. It is my opinion that the current zero interest rate policy of the Federal Reserve (Fed) is starving the Wall Street banks. Yes, banks can borrow from the Fed at near zero interest rates, reinvest in government bonds at a higher rate, and keep the spread. But, these banks are accustom to making big money and not being railroaded to government bonds to help keep interest rates low (Fed demanding banks to buy U.S. bonds). This squeeze into lower returning government bonds is certainly why banks like J.P. Morgan are making wild derivative bets. It also probably does not hurt J.P. Morgan to know that if they get in trouble the taxpayers will be called to bail them out once again.
The third week of May continued the downward movement in the markets as signs appeared that the U.S. economy is slowing, and Europe’s struggles continued. The Philadelphia Fed survey of regional business activity registered the first negative print in the monthly index since September 2011 going from 8.5 to -5.8. Spain and Greece continued to be the headline countries in Europe. In Greece, the prospect of departure from the Euro currency is growing by the day. The European Central Bank (ECB) President, Mario Draghi, indicated that the ECB will not keep Greece in the Euro at any cost. This is the first time we have seen the ECB as much as hint at letting Greece go. In addition, in one day alone, Greek banks saw almost $800 billion in deposits run out of the country. The flight of money leaving Greece (by Greek citizens) has been accelerating and is reaching a fever pitch. Across the Mediterranean, Spain is still struggling to keeps its sovereign borrowing costs contained as its rate for 10 year bonds has now risen well above 6%. Six percent may not seem like much, but it is 3.5 times more than the U.S. 10 year bond rate. Or, put another way; Imagine if the U.S. 10 year rate went from its current locale of 1.63% to over 6%. It would obviously be devastating to the economy.
To end the month, global markets weakened considerably in the face of declining global economic indicators and continued stress in Europe. A large number of global economic indicators were released and many, if not all of the most important, were negative. Here is a short list of the global indicators that came in with negative overtones – ISM U.S. Manufacturing Index, Chicago Purchasing Managers Index, U.S. Non-Farm Payrolls, U.S. Unemployment filings, China’s Purchasing Managers Index, Eurozone Unemployment, and Eurozone Purchasing Managers Index.
This time last year, and the year before, we sat at the same point where economic indicators were waning and the previous round of stimulation (money printing) was coming to a close. The reality is the economy can ill afford interest rates to rise. To keep rates down the Fed will need to continue to stimulate the economy through buying US Treasuries. But, this is an election year. The first two economic stimulus programs (QE1 and QE2) ended in the spring and by fall a new program was announced after watching the stock markets sell off. This year being an election year it is likely that if there is to be another economic stimulation it will come earlier than autumn to keep the topic of money printing far from the election. With this said, we may see some market weakness continue only to hear the Fed come in with more market pleasing economic stimulus.
We still hold a negative view on markets in the short-term as U.S. economic indicators are declining and the dysfunction in Europe is growing. The prospect of more money printing and the Greek elections on June 17th could push the market sentiment drastically in either direction. It is likely the markets will be range bound until some clarity is possibly found as we close in on the Greek elections, or the money printing resumes. Hold on to your hats folks, we are in for a bumpy ride with Europe now front and center of risk once again.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.402.6099.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.