Sell In May…? Rabo Warns “Expect A Deluge To Follow”

Authored by Michael Every via Rabo Bank,

There is an old market saying, “Sell in May and go away”. How true that might prove to be once again. After all, we’ve seen quite the risk-on rally in the past month and a bit, reversing much of the Covid collapse.

Moreover, consider the following:

If you are bearish bonds you can look to recent developments in Europe, where the German constitutional court claims superiority to the European Court of Justice among many wrinkles in this week’s shot across the ECB’s bows. That said, some bonds are still going to be favoured while this plays out – just core over periphery, one would imagine.

If you are bearish bonds you can look at the flood of supply about to hit us, especially as the US Treasury now has to issue to match the largesse being offered by Congress. USD96bn, with a 20-year maturity once again to join the curve and overall increases in long-term debt. Yet this is only May – afterwards comes the real deluge when the economy collapses in Q2 and revenues follow, while expenditure soars. 10-year US yields were up as high as 0.74% but are back at 0.69% now. However, please ignore silly-season stories about China dumping US Treasuries (again). If anyone can issue USD4 trillion in debt (or 20% of GDP) a year without smashing their bond market completely, the US can.

For example, the South China Morning Post reports an internal debate within China over its post-Covid policy response. The Finance Ministry allegedly wants the PBOC to purchase newly-issued and to-be issued special bonds, and at an interest rate of 0% according to a linked think tank; the PBOC believes that “relaxing rules could erode fiscal discipline and spending efficiency.”(!) So it seems China is also torn between a ‘Germanic’ response, which implies a prolonged growth slump (so sell stocks in May…which is bullish bonds by the way), or an all-in reaction, which as we keep pointing out will see USD/CNY soar (so sell stocks in May again…which is bullish bonds). The latest news is that China might be about to drop a numerical growth target for 2020 for the first time. That would certainly show that there is no huge stimulus coming. It will also create consternation among an entire generation of China GDP forecasters given the target has always been the actual figure up until now.

The irony is that this call to fiscal discipline comes from a country with what the IMF assesses as a double-digit consolidated fiscal deficit and incredible debt even during the good times, and where the social and political good, or the hope of eventual market domination and monopoly pricing, openly outweigh the need to actually make a short-term profit. Indeed, the South China Morning Post is inadvertently hilarious when it states that in China’s case “for defenders of central bank independence, Liu’s idea [of monetary financing of debt] risks opening a Pandora’s Box…” Take a step back and ask yourself how different any of this is going to be in most other economies within months. Again, that leaves May as a nice window for action.

Another reason to think the same: the continued ratcheting up of US-China geopolitical tensions. Yesterday President Trump called Covid-19 a “worse attack” on the US than 9/11 or Pearl Harbour, and he continues to point the finger of blame at China. Secretary of State Pompeo has likewise announced he will delay a mandated report to Congress on Hong Kong’s autonomy due by 25 May “to allow us to account for any additional actions that Beijing may be contemplating in the run-up to the National People’s Congress that would further undermine the people of Hong Kong’s autonomy.” This comes after the Beijing liaison office in Hong Kong yesterday called protestors there a foreign-instigated “virus” aimed at independence, and stated the central government would not sit idly by in the face of such a threat. As the Wall Street Journal notes, “The Trump administration has moved to involve much of the US government in a campaign that includes investigations, prosecutions and export restrictions. Nearly every cabinet and cabinet-level official either has adopted adversarial positions or jettisoned past cooperative programs with Beijing, an analysis of their policies showed.” Indeed, even Steven Mnu-China has stated Beijing must stick to the terms of the recently-agreed “phase one trade deal” or face “very significant consequences”. In short, there are no doves left in the coop, it would seem, only China hawks. So sell CNY in May then?

Let’s recall that other key emerging markets continue to be extremely bold in their policy choices, to an extent that usually sees them punished eventually: Brazil has just slashed interest rates a further 75bp, more than we or the consensus had expected, to a new historical low of 3.0% and is considering one more final cut in this easing cycle; Turkey’s policy response to a slumping economy and virus problems is already seeing TRY at a record low of 7.2077 at time of writing. Lots of selling and it’s still early May.

Lastly, we have the recent data. Australia ran a huge trade surplus of AUD10,062m in March, up 15% m/m and far more than expected, which will provide the usual fillip to very weak Q1 domestic demand, with imports -4% (matching a local services PMI of 27.1). However, China’s Caixin services PMI at 44.4 vs. hopes of 50.1 says no recovery ahead. China’s trade data also shows April exports 8.2% y/y, which is very hard to believe even given the rush on PPE, and imports -10.2% y/y, which is depressingly easy to believe – and again says no recovery ahead. Australia and AUD should take note.

For all of us, as we re-open May will show us just how many firms are going to fail in this new post-lockdown normal. US ADP jobs printing at minus 20 million yesterday and media reports that temporary job furloughs are becoming permanent ones says we should expect a deluge to follow.