The old expressions is to sell in May and come back again in the late autumn or early winter (variously September through to November). This old investing adage has been looking a bit tired for years now and as Interactive Investor points out doesn’t seem to have been true for quite a few years now. According to their reckoning, if we go back to 1986, between 30 April to 15 September (typically the date closest to St Legers Day), the FTSE All Share and the FTSE 100 have fallen 15 out of 33 times (45% of cases), making the old adage inconclusive. “Last summer saw comparatively modest falls in the FTSE All Share and FTSE 100 of 2.1% and 2.7% respectively. The cruelest summers of the last decade were not surprisingly during the financial crisis in 2008, where the FTSE All Share and FTSE 100 fell 14.4% and 14.5% respectively. Yet patient investors who hung on in there would have enjoyed a 19% positive bounce the following summer. Yet the falls we saw between 30 April – 15 September 2008, during the financial crisis, are well behind those of  2001 and 2002, where the FTSE All Share fell 19.7% and 22.6% respectively. The FTSE 100, meanwhile, fell 20.3% in 2001 and 22.4% in 2002.”

Now that doesn’t mean that there aren’t lots of things to worry about anyway. My own hunch is that we are just at the beginning of an especially egregious meltup where stockmarkets will bounce back aggressively. Clearly, there are lots of people who think that’s utter rubbish. Perhaps one of the more interesting contributions to this debate comes from Michael Horan, who I Head of Trading, EMEA at BNY Mellon’s Pershing. He thinks that the current bull market is the creation of excessive ETF trading. Here’s his analysis:

“ …..the growth of passive and ETF investment since the Global Financial Crisis has seen unprecedented levels of capital flow into liquid large-cap stocks, shifting the industry into a pedestrian investment environment. At the same time, the soaring demand for ETF products is triggering lower liquidity in smaller stocks that do not benefit from inclusion. This is concentrating investor allocation into a comparatively small number of stocks, reducing liquidity across the rest of the market and causing artificial highs in major indices. Additionally, the implementation of MiFID II’s research unbundling has created lower company coverage on small and mid-cap stocks. This creates two problems: much lower liquidity at the smaller end of the market – which we are seeing already – and more capital into large-cap stocks. This, combined with the broader shift to passive investments and continued inflows into ETFs and index tracker funds, is artificially increasing prices and causing investors to herd into large-caps. Global capital markets are at an inflection point. Increasing regulation, global macroeconomic risks, and the consequences of a rise in passive investing has placed a significant strain on global market infrastructure. New record highs for equity markets cannot continue forever, and the return of volatility seen in 2018 – as well as the recent treasury yield curve inversion – were warning signs to the global financial system. It remains to be seen how the new market environment will handle a bear market or regular bouts of volatility, but the warning signs of significant liquidity pressures are there”.

I’m not sure I agree with this analysis, not least because Michael seems to have missed the fact that most really big institutional investors don’t use ETFs. In fact, we’d all be surprised by just how much they use a) futures and swaps b) actively managed funds and c) (the killer) actual individual stocks. Shock horror! But what Michael is right to draw attention to is that quant-driven strategies are becoming more powerful, some of them passively implemented, others using a much more active framework. What these combine to produce is a strong push into the most deeply liquid, momentum-driven stocks – notably in technology. I’d also agree with Michael that liquidity amongst smaller cap stocks has declined markedly, creating huge pricing anomalies.

Stepping back from these debates about short term movement’s I think it is nevertheless useful to ponder where we are in the cycle of markets. I think virtually everyone agrees we are late in a cycle, we’re just not sure which cycle. There is a pervasive sense of a euphoric high before the inevitable cold turkey – a moral narrative that appeals intuitively to us all. Analysts at Fidante have a nice and simple way of divining where we are in the stock market cycle – see the diagram below. By their reckoning, we are in the BOOM bit of the cycle. Most assets should do well in this scenario, bar one. Gold. According to Joachim Klement, Head of Investment Research at Fidante Partners,  “sentiment for gold is too optimistic, in our view, and investors are not following through on this positive sentiment by investing into physical gold ETFs and funds. Given the seasonal decline in demand for physical gold in the second quarter, we expect gold prices to decline in the coming months.”

Joachim Fels, at Pimco, has an alternative take on the cyclical nature of financial markets, outlined in a blog entitled A Tale of Three Cycles. He argues that there are three main macro factors for markets – “the business cycle, the liquidity cycle, and the political cycle. These days, each of these cycles is global. The three interact and influence each other, but each has its own key driver.” Markets move very directionally when all three of these cycles align, either up or down. In 2018 we had a clear alignment of all three pointing downwards. Tariff wars with China, slowing global growth in trade and stock markets looking expensive.

But Fels reckons we’ve now seen these three cycles decouple, with at least two moving in the right direction.

“China’s purchasing manager indices (PMIs) ticked up in March, the European PMIs have been bumping along the bottom in recent months, and advance estimates of first-quarter U.S. GDP came in higher, year-over-year. With China’s credit and fiscal stimulus likely to find more traction in the coming months and global financial conditions having eased substantially since the start of 2019, a moderate recovery in global growth in the second half of the year appears to be in the cards”.

The other big tailwind is the pivot on monetary policy which is clearly moving back into an expansionary phase.

The one headwind?

The political cycle, which is moving in the opposite direction, especially in Europe which not only faces an outbreak of tariff wars but also lots of political uncertainty (although personally, I think this is a little overdone).

“Taken together, with markets now fully priced for the Fed’s triple dovish pivot, the global business cycle having bottomed but unlikely to produce fireworks in the remainder of the year, and populism likely to reveal more of its ugly face in the coming months, global risk assets will most likely lack a clear direction this year and could become more volatile again”.