Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

CHINA SERVICES PMI STRENGTHENS TO 53.5

HSBC China Composite PMI™ data (which covers both manufacturing and services) signalled the thirteenth successive monthly expansion of Chinese business activity in May. That said, the rate of activity growth weakened for the second month in a row, with the HSBC Composite Index posting at 51.2, down fractionally from 51.3 in April.image

May data indicated that an expansion in service sector business activity was the main factor driving overall output growth, as manufacturing production contracted for the first time in five months. Furthermore, the rate of activity growth at service providers accelerated to the sharpest recorded in eight months. This was signalled by the HSBC China Services Business Activity Index posting at 53.5 in May, up from 52.9 in April.

Business activity growth at Chinese service providers was supported by a further increase in new work in May. Moreover, the latest increase in new business at service sector companies was the sharpest for three years, with panellists highlighting a general strengthening of client demand and the impact of new projects. In contrast, new business placed at manufacturers in China fell for the third successive month, albeit marginally. At the composite level, new orders increased at a moderate pace that was the strongest in three months.

In line with the trends for activity and new work, service sector employment expanded at a faster rate in May. Moreover, the latest increase in staff numbers at service providers was the fastest since January 2013. Manufacturing employment meanwhile declined for the nineteenth successive month, albeit at the slowest rate since February. Overall, faster payroll growth at service sector firms offset sustained job cuts at manufacturers, leading to the first increase in composite employment for three months.

Latest data signalled a fourth successive monthly fall in backlogs of work at service providers in May. That said, the rate of depletion was only slight. Chinese manufacturers meanwhile reported an increase in the level of work-in hand (but not yet completed), albeit at a fractional rate. Service sector companies in China saw a further increase in their average cost burdens in May. That said, the rate of inflation was modest and slower than the series average.

Meanwhile, average input costs continued to decline in China’s manufacturing sector, though at a weaker rate than in April. At the composite level, input costs fell again in May, albeit at the slowest rate in nine months. Average prices charged by service providers were little changed from the previous month in May. Manufacturers, on the other hand, discounted their selling prices for the tenth month in a row. Consequently, output prices fell slightly at the composite level.

SEASONALITY OF EQUITY RETURNS REVISITED

BMO Capital updates the equity seasonal patterns with the typical sell side sugar coating to reduce your stress during the next several months:

“Sell in May and go away” has been a Wall St. adage for decades. Tradition holds that investors sell their stocks in May and stay away from the market until the end of October to improve returns. Indeed, historical performance patterns appear to support this. As Exhibit 1 shows, April 30 thru October 31 is traditionally the weakest six-month period for S&P 500 performance by a wide margin, while October 31 thru April 30 is the strongest.

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A closer inspection of this seasonal period reveals a more complicated backdrop. For instance, analyzing all years since 1950, we found that nearly two-thirds of the time returns were positive for the April 30 thru October 31 period (Exhibit 2, left chart) with an average return of 6.9% for the S&P 500. By contrast, negative years proved to be brutal with the S&P 500 averaging an 8% loss.

However, we find it interesting that 10%+ gains are more common than the 10%+ losses some investors like to associate with this period. In addition, “Sell in May” has not worked out all that well in the current bull market – four out of the six years yielded positive returns and for the two years where returns were negative the market was dealing with geopolitical shocks (Exhibit 2, right chart).

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Objectively:

  • This is a probability game and the average return April to October is generally below what short-term debt instruments offer. The probability-weighted return for this period is +1.3% with 38% chances of losses, a huge contrast with the other half-year.
  • An even closer inspection reveals more disturbing trends. Since 1980, twenty-four of the 35 years were positive during the May-Oct. period but in ten of these positive years, equities actually dropped 5% or more within the May-Oct. time frame before recovering. In effect, in 21 of the 35 years (60% chance of losses) since 1980, equities went trough a rough patch.
  • I found no relationship with either trends in inflation, interest rates or valuation to explain the weakest May-Oct periods. This means that essentially anything can happen during that period.

It may be that investors are trigger happy after their Nov-May gains and, seeking a stressless  summer, trim their equity holdings in the spring and are prompt to react to any negative event, including geopolitical shocks. BTW, the 7.1% gain in 2014 occurred thanks to a 8.2% jump in the last 2 weeks of October, after equities had sank nearly 10% between mid-September and mid-October…Had we stopped the clock October 15, only 3 of the 6 years of the current bull market would have been positive, one being a low +1.0%…