Sell in May and go away? It depends on the Fed

The saying goes, “sell in May and go away”, due to the historical underperformance of the US stock market between May and November, compared with a traditionally more robust performance between November and April. The analysis of this famous saying proves that there is something to this adage, since 1990, the average gain on the S&P 500 between May and October is 2%, whereas the average return between November and April is 7%. Of course, this pattern does not always hold, it didn’t in 2020, and it may not in 2023 as the Fed nears a turning point in its most aggressive rate hiking cycle in decades. However, it is worth considering before you trade this week, especially with the added burden of macro risks and another big week for Q1 earnings.

Amazon: is the sell-off justified?

April came and went in a blur, however, stocks were mostly higher last week, even if they came off the boil at the start of May, when most of Europe was off for the May-day bank holiday. The S&P 500 gained 0.87% last week and was up some 2.75% in April. If it’s true that returns slump to 2% on average between May and October, maybe it is time to book profits and take the pressure off for a while? The market can do funny things. For example, Amazon is still getting punished for the weakness in the growth of its web services business in Q1 (even though growth was stronger than expected), and for the bleak outlook that it painted for Q2. Its stock price fell more than 3% on Monday, and in pre-market trading it is down a further 0.5%. Interestingly, FactSet, the data analytics provider, has said that Amazon is the largest contributor to earnings growth for the S&P 500 in Q1, and it is expected to maintain this title for the consumer discretionary sector for all of 2023. Partly this is due to favourable comparisons with 2022, for example Amazon posted net income of $3.2 bn for Q1 2023, compared with a loss of $3.8bn in Q1 2022. But will this analysis help to lift its share price? The stock has fallen sharply in recent weeks, but it is still up more than 19% YTD. However, it is lagging its tech peers, for example, Facebook parent Meta platforms has seen its share price grow by nearly 100% YTD. While Amazon’s boost to the S&P 500’s overall revenue growth rate does not directly lead to a boost in its share price, some traders may use this as a basis for buying Amazon based on two factors: 1, its revenue-generating performance has improved dramatically. 2, its web services business model is still extremely strong. If we get a soft economic landing, then businesses may scale up their cloud computing budgets, and we believe that the cloud is the future, especially when compared with expensive and energy-intensive data storage centres and servers. Thus, Amazon’s share price dip may not last, even if it has had a bad start to the month.

The case for, and against stocks right now

Right now, the balance of positives and negatives for stocks and other risky assets are balanced. On the positive side: there have been some notable outperformers during earnings season on both sides of the pond, and some key earnings metrics are running higher than their 12-month averages. The corporate buyback window is also approaching, and there remains expectations that the Federal Reserve will move to the side-lines after this week’s expected rate hike. However, to counter this good news: there is concern that there is narrow upside leadership and that there is weak market breadth with fewer companies engaged in the rally in stocks in recent weeks. Added to this, there is a fear that the Fed may not be as partial to a pause as some expect and on top of that a slowdown in Chinese manufacturing growth for April, and service sector expansion also eased, which is weighing on the “strong China” narrative. Fears about a row in the US over the debt ceiling are also brewing, and they may get worse as we progress through May. Although the technical debt ceiling was reached in January, when the US’s debt level reached $31.4 trn, the Treasury has been able to enact a series of “extraordinary measures”, which should last until early June. Thus, expect the news flow around the debt ceiling to increase in the coming weeks, which could lead to volatility for risky assets and Treasuries. Treasury market volatility has been extremely low in April after the wild swings in March, however, don’t bank on this lasting if the debt ceiling issue blows up.

A quick word on the Fed

Ahead of the much-anticipated Fed meeting that concludes on Wednesday, the market is expecting a 0.25% rate hike, to 5-5.25%, with a near 95% probability, according to the CME’s Fedwatch tool. This would be the fastest rate hiking cycle in 40 years as the Fed struggles to bring down inflation. The main event, however, will be what the Fed does next. The market is expecting 75bps of rate cuts by January 31st, 2024, and we expect that the Fed’s communications around future policy decisions will be more important to risk sentiment than the actual rate hike. There are signs that the economy is cooling, for example a weak US housing market and signs of cooling consumer demand, added to this the recent banking turmoil could impact lending in the US economy, which could also force the Federal Reserve into a pause. However, some argue that it is too early for the Fed to pause, and instead they should signal that they will continue to hike for a few reasons: 1, JP Morgan bought First Republic bank, which is easing concerns about the US regional banking sector and 2, the prices paid component of the ISM Manufacturing survey for April jumped to 53.2, the market had been expecting 49.4.

The need for forward guidance

While there are fears about a recession, the bigger concern for the Fed is that the US economy continues to grow too fast to bring inflation lower. Thus, the Fed may not want to be too dovish at this week’s meeting, since the market tends to run with it and push risky assets higher thus boosting the wealth effect in the economy. The Fed could maintain a bias towards raising interest rates due to the inflation issues, rather than signalling a firm pause, and maintain its commitment to being “data dependent”. It is worth noting, that at this junction for monetary policy, when the outlook is extremely confusing, the market needs lots of forward guidance, thus the outlook for financial markets this week is pretty much totally dependent on the Fed.  

ECB aggression could send euro stratospheric

Elsewhere, after the dovish BOJ and another expected 50bps of rate hikes from the ECB on Thursday, EUR/JPY is at its highest level since 2008! We could see upside euro strength seep into other crosses this week if the ECB maintains a more hawkish stance than the Fed. This is good news for the euro bulls, but a strong euro may not be great news for the overbought European luxury sector. In essence, everything hinges on the central banks this week.