The S&P/ASX 200 has bounced 5.16% from early April lows to be around 50 points above the psychologically important level of 6000. The question clearly becomes; is this bounce sustainable, or will the Australian share market fade from here? Is it time to “sell in May and go away”?

From what I understand “sell in May and go away” is a northern hemisphere derived saying to describe the cyclical slowdown that occurs over the northern summer months. As the weather warms up and the days get longer, traders cut their positions and go on holiday. This is particularly relevant to commodity traders. (You can read Peter’s view on “sell in May” here.)

The local perspective

In Australian equities, “sell in May and go away” refers, more directly, to the fact that three of the big four banks will go ex-dividend in May and broader yield support for the index will fade. Seasonality works well in Australian equities, and you usually see a run-up in demand for banks start around 45 days ahead of their full year results and dividends.

For all the headlines and noise about the banking Royal Commission, the S&P/ASX 200 rallied over 5.00% through those headlines. Again, this was driven by the relentless demand for fully-franked yield streams, in what remains an ultra-low interest rate environment.

At the same time, commodity prices rose and the Australian Dollar fell, meaning just about every sector in Australian equities had some sort of macro sentiment tailwind.

But here we are and the question is: what happens next?

My view remains that volatility is increasing and we are broadly in index trading ranges. For the S&P/ASX 200, which in reality is a domestic income-focused index, the top of the trading range, around 6100, appears to be when the market is effectively cum solid dividends, and the bottom of the range, around 5700, appears to be hit when the market has no cum-dividend support.

I believe there’s a clear reason for that and it’s because for hedge funds it is a very expensive business to be short large fully-franked dividends. I believe you see hedge funds cover short positions in the lead up to big fully-franked dividend payment periods, then recommence shorting once dividends have been paid.

Clearly, the ex-dividend markets have less investor support and the shorting finds less resistance. In fact, it can be like a knife through butter.

Sustainability factors?

On that basis, I suspect the shorters will be back in a big way once the dividends are paid and capital prices for Australian banks could make fresh lows on this move. I want to make clear I am not short Australian banks in my fund, I’m just trying to think about what comes next and how it will affect the price of the S&P/ASX 200.

Also, at a broader earnings level, we are not seeing widespread consensus earnings upgrades that are required to sustain a rally. The current Macquarie Australia Conference, which sees most of large cap Australia present and talk about current trading conditions, has been mixed. Stocks such as JB Hi-fi (JBH), Amcor (AMC) and Invocare (IVC), hosed down earnings forecasts, while on the other hand, Qantas (QAN) upgraded their profit forecast. It’s been a genuine mixed bag, and not enough profit upgrades to drive broader index gains in my view.

The final issue is that it’s getting harder to find Australian stocks you would actually buy or add to at current prices. That is always a sign the market is a bit ahead of itself and could potentially pull back a notch in the next few months.

That includes many of the Australian stocks I’ve recommended in these notes. I am not saying it’s time to sell them, but stocks like Aristocrat (ALL), Treasury Wine Estates (TWE) and Speedcast (SDA) have had almighty runs, and on short term technicals appear stretched. On longer-term valuations I have no concerns, but in the very short-term ALL on a relative strength index (RSI) of 80, TWE on an RSI of 72, and SDA on an RSI of 76 could all pause for breath for a little while.

In long-term structural growth cycles there are always periods of stretched technicals. To a long-term investor that is, and should be, meaningless, but to the short-term investor/trader momentum is an important variable.

Pause for breath

I looked across my Australian screens today and there are many leading Australian industrial stocks with stretched short-term momentum indicators that are likely to also pause for breath. In that list, I’d include widely held names like CSL (CSL), Sydney Airport (SYD), Goodman Group (GMG), Macquarie Group (MQG) and Wesfarmers (WES) to name a few. Most of those names also now look stretched fundamentally, and I wouldn’t be surprised to see some profit taking in May.

To me, it is all lining up as a “take a few profits in early May” situation in Australian equities, while the S&P/ASX 200 is above 6000. My view is you will get your chance to redeploy that cash at better risk adjusted entry prices over the next few months, and the “dividend yield bid” will evaporate when the banks go ex-div. Also there are no large dividends again until the August full year reporting season.

Banking a few trading profits and having a little cash is not a bad thing as volatility rises. I know we all cheer the up days, trust me I do too, but we all rue not having enough firepower (cash) to deploy on the down days.

My core thesis this year, as I presented last month at the Switzer Strategy Days, is that interest rates, inflation and volatility have all bottomed for your lifetime. On that basis, and there’s no reason to believe that thesis isn’t correct, in fact, there are more reasons daily to believe it is correct, we are all going to need to trade our portfolios more to capture the best available total return from equities as an asset class.

I can hear the stockbroking community cheering as I write that, but my fund has increased its portfolio turnover to take advantage of increased volatility and that decision has added to our returns.

Short-term tactically bearish

You simply have to be a little more contrarian this year. That is why I am typing this note today. While it would be very easy for me to cheerlead and bang the drum bullishly on the S&P/ASX 200 recovering through 6000, today I am actually questioning the sustainability of the rally and encouraging you to take some profits where things are a little stretched.

I hope I am wrong and the S&P/ASX 200 powers ahead, but my instinct is this rally above 6000 will be short-lived and it’s time to be a little more cautiously positioned and wait for a better opportunity to deploy capital.

Between late May and early August, I believe you will get a chance to deploy capital in Australian equities at the lower end of the current trading range of around 5700. That’s not a big call as we were trading at that level 30 days ago!

So you could say in today’s note I am going “short-term tactically bearish” Australian equities above 6000, taking some profits and raising cash levels.

I guess 99% of readers don’t want to hear that but with me that’s what you get: exactly what I think.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.