When the weather is not cooperating in Southern California this time of the year, the natives will regale you with the atmospheric conditions that produce the dreaded June Gloom conditions. If you happen to have just spent the winter in Chicago or Boston, you might be wondering what all the fuss is about.
Gloom hangs over the markets today. The natives are swooning at every jobs figure that does not defy gravity and the European crowd are indulging in dramatic pratfalls that make their soccer (sorry, football) melodramatics look prim and restrained. For Europeans, the crisis that was “Made in America” does not fully explain how Greece ended up in so much trouble. The Europeans are trying desperately to avoid answering the hard questions that are being asked by the voting public and the bond market.
From a macroeconomic point of view, the global economy is still recovering from a severe financial crisis. That recovery has actually been delayed by all the public funds and government projects that have sought to cushion the blow to the economy and its citizens. Throwing more debt on the pile of debt that got us into trouble in the first place has not worked. The Austrian School of Economics was first and most vocal in pointing out that the bad debts had to wash through the system before the economy could return to a healthy basis and start growing again. However, the thought of letting the market clear out the bad debt was a political non-starter in countries as diverse as China, the US, Brazil, France, Germany and the UK.
But now, after three years of pump priming, disaster management and wishful asset valuations, the markets are finally getting a chance to sort out some of the wreckage. The FED has admitted that its monetary stimulus has not produced the desired results and the Germans are starting to talk about how private investors may end up wearing real losses when Greece’s debt is restructured (and/or defaulted upon). The US housing market is still trapped in suspended animation but, with the Case Shiller index double dipping, it should not be long before real solutions are proposed and acted upon.
What does this mean for investors?
In a word: Patience.
Although we mentioned that it looked like another “Sell in May and Go Away” year, we did not take nearly enough of our own advice and our portfolios have suffered accordingly. Investors who joined the rally late (in the early part of this year) will be keen to sell into any rallies now that the markets have “confirmed” their initial bias that risk assets are to be avoided. A quick break to the upside will be smothered very quickly.
On the downside, most of the bad news in the market is actually pretty old news. The problems in the developed markets have been worked over for several major news cycles: American mortgages underwater, sovereign debt issues in Europe and budget deficits almost everywhere. In the developing markets, the worries about inflation, hot money, loose monetary policies and rising currencies are not fresh. All of this means a simple relapse into 2008/9 conditions, while not impossible, are nonetheless extremely unlikely. There is plenty of money swirling around the system to capitalize on any sizable dips in the financial markets.
Resurgence in Biotech
Although it is too early to say for sure how strong the trend is, we have noticed a fairly broad improvement in the biotech (XBI), medical devices (IHI) and health care (XLV) sectors. The numbers are not conclusively high at this point but they are better than most of the alternatives in the market.
Some market observers have cherry picked past data and noted that times of economic distress are often also times of tremendous technological innovation as well. Perhaps the energy released by a Schumpeterian “Creative Destruction” wave is fueling innovation in the biotech and medical devices sectors. Or it could be simple rotation into what could be viewed as a more defensive sector in the US at this point.
There is no question that the medical/pharmaceutical/health care complex in the United States is ripe for innovation. Andy Kessler has explored this area since at least 2007 with the central thesis that the delivery of medicine and health care ought to enjoy some of the liberating innovation and efficiency gains that we have seen in the IT sector since the invention of the integrated circuit. Was he a bit early? Perhaps, although there is no question the cracking of the human genome is just now starting to pay dividends in terms of new medicines and delivery systems wending their way through the drug approval process.
Have some cash ready for Autumn Opportunities
So, we may have some excitement on the biotech front. We will definitely see some frothy IPOs in the social networking space (Linked In, GroupOn, Facebook…) which might help spark some small return of investor appetite for risk. And we can definitely look forward to a good scare on the European sovereign debt crisis and some worries about China’s rediscovery of the business cycle which will frighten investors back to the sidelines. Therefore, until the RSI numbers start to improve into the 20’s, there is no rush to get back into the market.
If the second half of “Sell in May…” hold true, there should be some good opportunities in the fall. Keep a bit of cash available and be ready to rotate into different asset classes after the summer torpor lifts.