What Will Kill the Mother of All Rallies

What Will Kill the Mother of All Rallies

The 2019 stock rebound has turned into one of the best bull market rallies in decades, rising 16% thus far and on track for the fifth best year-to-date performance since the Second World War, according to CFRA chief investment strategist Sam Stovall. But while he sees stocks hitting all-time highs before the month is out, Stovall also says historical trends indicate that the rally will end starting next month.

A “sell in May and go away” phenomenon is beginning to take shape, Stovall told CNBC. “The market could end up attempting to digest some of the gains that it’s already experienced,”

Forces that Could Kill the Great Rebound

·           Sell in May, go away for 6 months

·           Peaking margins

·           Slowing GDP growth: U.S. and globally

·           Slowing S&P 500 earnings growth

Source: CNBC; Financial Times.

What it Means for Investors

The best-performing rallies throughout the first four months of the year since World War II have tended to turn badly in month five. On average, stocks were up only 0.01% in May. Between May and October, the historical data show an average price gain of just 0.05%. “Half of the time the market was lower in that six month period,” Stovall added.

Historical trends aside, new threats to corporate profit margins are emerging, giving investors more fundamental reasons to worry about equity prices. Bridgewater Associates, the world’s largest hedge fund, is warning in a report this week that U.S. profit margins are reaching peak levels after decades of improvement. “Some of the forces that supported margins over the last 20 years are unlikely to provide a continued boost, Bridgewater said, per CNBC. Without consistent margin expansion, stock prices would be 40% lower than they are today, the report said.

Leuthold Group’s Jim Paulsen is also waving a warning flag. While Paulsen sees favorable policy support from the Fed and White House that could help the S&P 500 rally at least another 10%, he believes the next few months will be a crucial testing period whether or not the economy is “falling off a cliff.” “Recession and bear market fears would return very, very quickly and very harshly,” he told CNBC.

On that note, the U.S. economy is already moderating to about 1.5% to 2% growth, according to some estimates. Weaker demand from a slower growing Chinese economy and a global economy weighed down by high debt levels and geopolitical risks will continue to dampen the growth outlook. While the Fed’s more dovish stance is supportive of equity prices, slower earnings growth will act as a major headwind.

Looking Ahead

With stocks inching towards their all-time highs amid a rather tepid outlook for the U.S. and global economy, investors may want to consider more defensive sectors moving forward. Stovall’s suggestion is to wait until the last week of April to take advantage of the last surge in the market before moving into more safe-haven sectors like consumer staples and health care.  

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