“Sell in May and Go Away”, that’s one of the best-known adages of the financial market. It refers to a XIX century custom of English bankers, businessmen, and aristocrats who left London during hot summer days to enjoy the countryside.

In the northern hemisphere, it is a relatively common practice, due to better defined seasons and the summer vacation, where in the US usually spawns between Memorial Day (May 28th) and Labor Day (first Monday of September).

In the US, “Sell in May..”usually spawns between Memorial Day (May 28th) and Labor Day (first Monday of September).

Data do not totally comply with the proverb, but the evidence supports not a total “sell” movement itself, but somehow also a “hold” position. In other words, investors may hold positions into safer assets during the summer and move towards riskier ones during winter.

Mark Hulbert, a columnist for MarketWatch analyzed data from 1897 on and found out that the years of a presidential term have more influence in this scenario, than the adage itself. The “winter” period in the third year of a presidential term averages an 11 pct gain, while the “summer” averages a slight loss. In years one, two and four, “winters” are up about 3 pct, while “summers” gain about 2 pct. The case of “Sell in May…” is still up, although.

Bearing that in mind, while not a classic case of “Sell in May…” presidential year, the current moment saturated somehow by strong externalities caused by the Trump presidency.

Among them, are:

  • The Russian case (in several instances);
  • The Commercial war recently declared against different countries, especially China;
  • Syria;
  •  The Iran nuclear deal withdrawal;
  • The OPEC output cuts, causing the rise of oil prices, leading to outlooks of higher inflation in the US, consequently increasing the chance of additional interest rates hikes;
  • In the end, leading to a renewed pressure on the US Treasury bonds yield and US Dollars.

Previously to these conditions becoming worse, emerging markets flourished with intense gains since the beginning of the year. Up to the month of May, not only emerging market currencies, but also a whole sort of assets could follow the mild steadiness of the US Market, due to doubts on the number of Fed Funds rate hikes. US dollar reached new bottoms by February, remaining quite stable up to the end of April.

That is the key date. The proximity of May theoretically triggers for the selloff movement, making all the factors cited above matter much more in the mind of traders than before. That is obviously nitpicking, but offers the perfect excuses for profit taking, search for notoriously more secure assets (i.e. US Stocks, Treasury Bonds, and Dollar), and spend well-deserved time on vacation.

Dow rose almost 1,000 points since the beginning of May, while 10-year Treasury yield broke the 3 pct barrier, and DXY Dollar Spot index rose 6.5 pct from the lowest point in the midst February. On the other hand, emerging currencies, stocks, and bonds were the primary ‘victims’ of this atypical selloff.

Emerging Market currencies, stocks, and bonds were the primary ‘victims’ of this atypical selloff.

As seen below, emerging stocks fell into a strong dip up to the end of May, except for the land Chinese market.

The moving average show loses of 3.8 pct from April 28th on, with no short-term signs of refresh, while in the same period, Dow rose above 2 pct.

The moving average show loses of 3.8 pct from April 28th on

We show above Ibovespa (Brazil), JSE (South Africa), Mexbol (Mexico), Borsa Instanbul (Turkey), Moex (Russia), Shenzen (China), SGX (Singapore), Bux (Hungary), Kospi (South Korea), Wig (Poland), TWSE (Taiwan), and Hang Seng (Hong Kong).

In the period, only China mainland and Hong Kong did not present loses.

Emerging markets currency followed the same step, as seem below on the MSCI Emerging Markets Currency Index. The end of April remains as the key date.

By following the previous pattern, it is possible that current “Sell in May…” will end this week, led by a period of lower market volumes, probably also less volatility. As for the climate, the next summer is quite promising, with forecasts of higher temperatures and clear skies.

In a scenario of high oil prices, the increasing demand for fuel might be an issue, particularly for US inflation forecasts, but since Fed officials agreed that results modestly above 2 percent target would be helpful in anchoring longer-run inflation expectations, oil prices may lose steam in the next few months. It brings us to the Shale Oil case.

The Shale Case

The shale revolution led to a rapid growth of the natural gas industry in the United States over the last several years. Production of dry natural gas increased over 50 pct, making the US the largest producer of natural gas, and gaining important positions as a large oil producer in the World.

According to the Bureau of Labor Statistics, producer states have been the epicenters of the recent shale revolution that has helped to increase jobs, infrastructure, and technology in the areas.

States such as Pennsylvania, New York, West Virginia, Ohio, North Dakota, and Texas are the main beneficiaries of the shale revolution.

Almost ten years of intense investments finally paid off in 2014, when the US flooded the market with shale oil and gas, leading to a price drop to the historic $26.21 a barrel in Feb. 2016, when producers were finally free to export their crude oil. From that lowest point on, price stabilized around $48 a barrel, making the extraction a quite balanced and profitable business.

However, shale oil and gas profit margins are tight, for the following reasons:

  • The costly extraction process through fracking, with intensive use of sand, in shortage recently;
  •  The lack of ports infrastructure capable of handling large oil tanks;
  •  Shortage of specialized technical personnel in most areas, from welders to engineers;
  • A bottleneck in the pipeline infrastructure, as well as the high shipment cost through rail or trucks, considered complex and dangerous;       
  • Moreover, the grade of the oil, since the one produced from fracking is a very light type, making it necessary to build new refineries, something difficult these days in the US, due to strong environmental regulations.

After a year of intense gains, the factors above forced producers to pull the breaks, reducing the general supply, making room for the movements from the OPEC to restrain the global output, in order to increase prices up to the levels observed today.

There is a comfort zone of prices above $60 a barrel for Shale producers

There is also a comfort zone of prices above $60 a barrel for Shale producers when considering the facts above, so keeping the costly production at a controlled level was a correct strategy until recently. Less production, similar gains.

Still, several recent signs of change are showing.

Data reveals that payroll employment in the producing areas have spiked on a seasonal adjusted basis in the Ohio River Valley region in the states of Pennsylvania, Ohio and West Virginia, previously known as the “Rust Belt”, known now as Shale Crescent USA Region, with new petrochemical plants built recently.

This area alone, according to a new Study by IHSMarkit released in March, would have a four times greater cash flow and save $3.6 Billion over a 20-year period, compared to similar plant on the Gulf Coast.

Shale Crescent USA is most profitable region in the world for a petrochemical plant and the US is now the leading world producer of energy.

It is most profitable region in the world for a petrochemical plant and the US is now the leading world producer of energy.

Yet another important sign comes, as the U.S. Energy Information Administration (EIA) released ten days ago, shale oil production is expected to rise by about 145,000 barrels per day to a record 7.18 million bpd in June, 144 thousand barrels/day above the current month and the 5.40 million bpd in June ‘17.

Natural gas production was also projected to increase to a record 68.1 billion cubic feet per day (bcfd) in June, against just 56.4 bcfd a year ago.

What Now?

We mention the movements in the American Shale industry, as it’s our perception since the first quarter that they will soon reenter the market to reclaim its position as a large global supplier.

Because the latest market volatility had its peak due to the increasing oil prices and the potential consequences in the American inflation forecasts, we believe that a renewed supply is the key to drop prices below $70 a barrel.

We believe that a renewed supply is the key to drop prices below $70 a barrel.

Not even the lack of the Iranian supply would be enough compared to the Shale ‘power’.

The gap of over 10 pct between the Brent (London) and WTI (New York) contracts, the largest since March 2015 (18.9 pct), shows already signs of higher American supply. June is a key month for the industry, especially in the north, installed in areas majorly isolated during winter. The forecast of a dry, hot summer helps the industry in many ways.

To sum up, we believe that most of the recent volatility heat fed the adage of the “Sell in May…”, which was atypically fueled by the series of externalities within the Trump administration, along with the OPEC’s output cuts that coincidently lead to an oil prices hikes in the beginning of May.

Oil prices may go down, reducing the perspective of higher inflation in the US and the pressures for additional rate hikes, also sinking the demand for US Dollars.

A renewed supply from American Shale producers may curb the enthusiasm of OPEC’s members and soon, oil prices may go down, reducing the perspective of higher inflation in the US and the pressures for additional rate hikes, also sinking the demand for US Dollars.

If the Trump externalities do not get in the way again, June may be a less volatile, more boring market than May.

So we hope.