MARKET INSIGHTS
Leon H. Loewenstine, CPA, RiverPoint Capital Management, Managing Director and Chief Investment Strategist
William B. Greiner, CFA, Mariner Wealth Advisors, Chief Investment Officer
May, 2013
Analysts are fond of saying that during Bull markets, stock prices “climb a wall of worry.” Over the last
month, there have been a number of developments that indicate the economy may be entering what has
become the traditional summer “slow” season. We can analyze some of these trends, others we can’t.
But let’s talk about a few issues.
Stock prices worldwide have been on an upward trajectory for the last six months. Commodities have
been struggling, as economic marginal final demand trends have weakened. Also, gold prices have
declined significantly over the last month. What does this mean? Are we going to see the “Summer
Swoon” in asset values that has happened so often over the last few years?
All That Glitters
Gold prices have declined recently – down more than
20% from peak prices and down 7% this past month
alone. What are our thoughts on gold as an investment?
Following, we examine why investors should, or shouldn’t,
own gold.
Gold is an odd metal. It has little practical use, save jewelry
and Porsche sparkplug tips. As far as metals go, it is soft,
not durable. It doesn’t hold an “edge” well. It is heavy
– not to be used for “efficiency” purposes. Lastly, it isn’t
abundant – it is rather rare and hard to find. So why has the
world historically been attracted to the metal? And more
to the point, what may happen to gold prices as we move
forward through the final stages of the “Long, Hard Slog”?
Why Gold?
Gold is an asset that, contrary to some beliefs, has been
used successfully by investors and prudent central bankers
as an alternative to other fiat currencies. What do we mean
by this? The world’s central banks and economies trade
utilizing “fiat” currencies. A “fiat currency,” it is a currency
that derives its value from governmental regulations
and laws, and investors’ comfort with those regulations
and laws. Such is the case with all of the world’s major
currencies – the dollar, the euro and the yen, all are fiat
currencies.
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They are currencies people value due to their trust that the
governments that issue them will stand behind them. They
are in essence, backed by trust.
So is gold. It represents the world’s oldest fiat currency
– backed not by a governmental agency, but rather by
investors’ willingness to buy the currency from the holder
at a known price. The value does not depend on the
actions of governments; instead, it relies on investors’
(and bankers’) willingness to hold fiat currencies, or their
avoidance of these currencies due to uncertainties, and
levels of trust/mistrust.
Gold does not hold a real “industrial” use, consequently
some investors look at gold as an oddity – something they
have a hard time analyzing. But placed in the fiat currency
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MARKET INSIGHTS MAY 2013
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All That Glitters (Continued)
realm, gold becomes easier to understand from a rational
standpoint. Many serious investors, including most of the
world’s central banks, own gold for various reasons.. The
world’s investors have wanted to hold more gold over the
last 10 years than they have for some time. This has been
due to many factors, but the most powerful has to do with
the world’s vision of the value of the U.S. dollar in relation
to other currencies. Indeed, there exists a long-standing
relationship of gold prices and the exchange rate of the
dollar to other currencies. This relationship has been very
strong over the last 40 years. It is a “negative” correlating
relationship (-0.37 correlation coefficient for those quanttypes). In other words, historically when the value of the
dollar is declining, the value of gold has risen, and visa-versa.
Why does this negative relationship exist between the
price of gold and the value of the dollar? Both are fiat
currencies, as described above. The dollar gets its value
by the comfort central bankers and investors are willing
to assign due to how much they trust the government’s
backing of the dollar. When trust wanes, gold prices rally.
Gold is priced in dollars worldwide. Central bankers can
make an active decision regarding trust in the value of the
dollar (trust in the actions of the U.S. government), and if
they are uncomfortable, they can buy gold. This is a special
relationship between the dollar and gold prices.
Therein lies the reason to own gold. Concern of a
government’s intention or ability to back the value of their
currency, which brings on a decline in the value of that
country’s currency, and normally when a country’s currency
declines, stock prices suffer. What about now? With the
increase in economic momentum the U.S. is currently
experiencing – particularly in relation to foreign economies
– we suspect that the value of the U.S. dollar will rally in
relation to foreign currencies. With this in mind, now is
probably not the time to own gold, or add to positions.
Review of the Four
Cornerstones – Stock Prices
and Central Bankers Largesse
We have long held the belief that attempting to accurately
predict stock price movement is a tough, if not impossible
feat. As most know, we entered this year expecting higher
stock prices (our original forecast was more bullish than the
consensus at the time). Additionally, we raised our forecast
for the S&P 500 Index in late March. We now expect the
S&P 500 to trade upward to the 1,670 range later this
year (for those keeping track, the index currently stands
at 1,650).
Of our four “cornerstones,” one is currently in the
neutral camp (valuation), one is showing negative trends
(sentiment), one is slightly positive (corporate earnings
growth), and one is showing highly positive leanings
(monetary policy). The monetary policy cornerstone got an
additional boost over the last several months, as the Bank
of Japan has announced significant new quantitative easing
programs. Additionally this past month, the European
Central Bank (ECB) lowered interest rates by 0.25%. The
U.S. Federal Reserve is continuing its $80+ billion per month
bond purchasing program – so all three of the world’s
central banking systems are currently providing full-tilt
monetary easing stimulus programs.
The combination of these factors leads us to believe the
current upward momentum in the market should stay in
place. Don’t get us wrong – we wouldn’t be surprised to see
some sort of market setback sometime over the next few
months. But absent a negative catalyst, the markets should
continue to trend higher. That being said, it is worthwhile to
study the oddity of “Sell in May and Go Away.”
Sell In May – and Go Away
There are a number of market mantras or sayings of which
many investors are aware. “Don’t fight the Fed,” “Don’t
fight the tape,” “Three and a stumble” and “January
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MARKET INSIGHTS MAY 2013
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Sell In May – and Go Away (Continued)
effect” are some examples. All these sayings are based on
statistical information. Perhaps the phenomenon which has
had the most predictive power is the old saw, “Sell in May
and Go Away.” In essence, the Sell in May concept relies on
the seasonality of stock returns. From a historical standpoint,
if an investor were to sell all of their stocks at the end of
April, and buy them back at the end of October, that investor
would have fared much better than the “buy and hold”
investor.
Our friends at Stock Trader’s Almanac have compiled some
interesting data pertaining to the Sell in May concept.
Starting in 1950, if an investor had sold the Dow Jones
Industrial Average at the end of May and purchased again
at the end of October, their initial investment of $100,000
would now be worth $8,420,938! If an investor was so
hapless to invest at the beginning of May and sell at the end
of October, their same initial investment of $100,000 would
now be worth $83,740. The data does not include dividends
earned during these periods.
The phenomenon worked again last year – from May 1 to
October 31, 2012, the Dow Jones registered a price return
of -6.7%. Since the end of last October, the Dow Jones is
up 23.1%. Will the phenomenon occur this year? Will stock
prices struggle during the summer months?
Some Thoughts
We have written at length about the probability of a stock
market decline, as we have suggested that following any
20%+ move in stock prices without a 10% correction, the
market is poised for some type of correction. This is where
we currently stand. Consequently, we wouldn’t be surprised
to see some type of “correction” occur over the next few
months. Our work is telling us that if it occurs, the correction
should be limited to a normal 10% and not the start of
something bigger.
Why do we believe this to be the case? Our “Four
Cornerstone” work tells us the positives at work in the
market (rising earnings, central bank monetary policies)
offset current negatives (sentiment, valuation). Another Wall
Street saying is the possibility of the market experiencing a
“Summer Swoon,” where stock prices tend to decline during
the heat of the summer. This swoon has occurred each of the
last three years. Is it going to happen again?
Over the last three years, from the end of April, the market
experienced the following corrective actions:
2010:-13.8%
2011:-17.0%
2012:-5.5%
Last year, the Summer Swoon was less pronounced than in
the previous two years. Additionally, the rebound into the
end of the year (following the end of the swoon) was less
pronounced in 2012 than the previous two years. Why? We
suggest the following is playing out:
1. Surprises create volatility. Negative surprises tend to
drive stock prices downward – at times rapidly. Structural
changes with which the world has been wrestling
(Europe, Washington budget issues, China growth, Japan
deflation) are now well known. These socio/political/
economic “balance sheet” disruptors are now built into
investors’ thinking – the world’s investors have become
less surprised by events surrounding these systemic issues.
2. Earnings estimate changes can drive stock prices.
Revisions during the summer months have become less
pronounced as analysts have been systemically lowering
their expectations at the beginning of the year for the
year’s earnings results. The bottom line – if expectations
are systemically becoming more muted, downside
earnings adjustments are less pronounced, leading to
lower downside volatility.
Continued on next page »
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MARKET INSIGHTS MAY 2013
IN V E S T M E N T
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Some Thoughts (Continued)
A Final Note
3. Both the “Sell in May” and “Summer Swoon”
phenomena have become very well-known and
anticipated. When an oddity becomes mainline thinking,
the phenomena adjusts.
Jerry Miccolis, of our sister firm Brinton-Eaton, mentioned
4. The market appears to be absorbing bad news
well. Investors’ mindsets seem to be in a positive frame,
as compared to 2010 and 2011 when people were still
wrestling with structural problems and whose memories
of the 2008-2009 crash were still fresh.
5. Since the end of February, we have witnessed a
dislocation between “crowd” investor sentiment and
stock prices. Stock prices and crowd sentiment are
usually highly linked. Since the end of February, crowd
sentiment has declined (become less bullish) during a
time when the Dow Jones average increased by 13.6% in
value. This is odd. Don’t get us wrong. Crowd sentiment
is still bullish, but much less so than earlier in the year.
The “crowd” appears to be anticipating a correction
in stock prices. Normally a stock price correction is not
immediately forthcoming when this occurs.
Stock corrections can take two forms – price and time. A
“price” correction is more normal. However, at times, the
stock market is able to move sideways, letting fundamentals
catch up to stock prices. Considering the five points from
above, perhaps this may occur this summer – rather than the
normal “Summer Swoon.”
recently that all in the world is good – baseball season has
started. Jerry, being an avid St. Louis Cardinal fan (a team
that is easy to like) is high on his “Cards” having another
great year. We expect Leon and other Cincinnati fans are
hopeful for the Reds – looking for a return to the days of the
“Big Red Machine,” while Bill Greiner and our Kansas City
friends simply hope for a winning season – something their
Royals haven’t produced in decades.
We urge all our clients to enjoy this great time of year.
We will be back next month.
Leon Loewenstine, CPA
Managing Director and Chief Investment Strategist
RiverPoint Capital Management
William B. Greiner, CFA
Chief Investment Officer
Mariner Wealth Advisors
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opinion and forecast is based upon.
* Performance data sourced from Barron’s. * Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future
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