Monday Morning Outlook

Should You 'Sell in May and Go Away' This Year?

Will an historically bearish month buck the trend in 2013?

by 4/27/2013 10:52:17 AM
Stocks quoted in this article:

The major market indexes finished the week solidly higher, despite lackluster gross domestic product (GDP) data and even a fake tweet from the Associated Press. While the latest batch of earnings reports were mixed, the good seemed to outweigh the bad, with Wall Street bouncing back from last week's drubbing. Looking ahead, Ryan Detrick, CMT, offers some words of encouragement for the bulls, while Rocky White takes a look at what we might expect for the historically bearish month of May.

  • The chart pattern everyone is talking about
  • The importance of presidential cycles in May
  • Is optimism too high?

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus a featured sector to watch.

Notes from the Trading Desk: Climbing a Wall of Worry
By Ryan Detrick, CMT, Senior Technical Strategist

Todd Salamone is out again, as he is in Las Vegas at the Annual Options Industry Conference. I'll be filling in again this week.

You have to hand it to the bulls. After the S&P 500 Index (SPX - 1,582.24) had its worst week of the year, losing 2.1% two weeks ago, the bulls fought back nicely. As expected, the combo of 1,550 and the SPX's 40-day moving average were solid support.

Daily Chart of SPX with 40-Day Moving Average

Also, the CBOE Market Volatility Index (VIX - 13.61) has totally imploded from its recent 50% surge. Todd was all over this one, as he noted previous spikes of 50% have marked peaks in volatility and usually present good buying opportunities for equities. So far, so good.

Daily Chart of VIX Since November 2012

Sparking last week's rally were positive reactions to earnings. Although overall revenue is still disappointing, the recent batch of earnings was much better than what we saw two weeks ago. The one group that really stood out, though, is housing, as various housing names reported very strong earnings. I've said before that housing is the one area of the economy that will continue to lead, and the recent earnings and guidance from the group look very strong for future overall economic growth.

On the technical front, there's been a lot of chatter regarding a potential head-and-shoulders top forming on the SPX. If you believe this, then the SPX is currently in the process of making a "right shoulder" before an impending big drop.

Daily Chart of SPX Making Head and Shoulders

What we continue to find amazing is how quickly and well-publicized the bearish patterns are versus the bullish patterns. The SPX made a picture-perfect inverse head-and-shoulders pattern the last three months of 2012, yet all we heard then was how bad the "fiscal cliff" was going to be for everyone's portfolio. That pattern played out perfectly and led to the best first quarter since 1998. From an anecdotal point of view, we find this to be very bullish. Think about it: This recent bearish pattern isn't even completed yet, but we have nearly everyone talking about it, whereas bullish patterns get little to no love at all. Markets climb a wall of worry, right?

There are many concerns out there. From small-caps lagging, to bond yields soaring, to "sell in May and go away," to the aforementioned head-and-shoulders pattern, to "light volume is bearish," to weak breadth, to Transports lagging -- the list of concerns is long and worth noting. Now I'll add to it.

Last week, Barron's Big Money Poll had the most bulls in its 20-year existence. Currently, 74% of those polled were bullish over the next six to 12 months. This figure was just 46% six months ago. Of course, over the past six months, the SPX has added more than 10% and moved to new all-time highs, so the logical question is: If this group was bearish and very wrong back in October, what does it mean now?

Also, the action in the National Association of Active Investment Managers (NAAIM) survey is a concern. Active managers have drastically cut their exposure to equities recently, and previous peaks have eventually lead to SPX pullbacks. The pullbacks just took some time after the NAAIM rolled over, as both the February '12 and August '12 peaks in the NAAIM and subsequent rollovers were a few weeks before the SPX peaked and rolled over. Now, with a drastic drop in the NAAIM, one has to wonder if the SPX will be due to play catch-up soon and pull back.

NAAIM Sentiment since 2011

Now for the positives. I see all of the concerns and am not blind to them, but continue to think siding with the bulls is the way to go here. At the very simplest way to look at things, the trend is up until it isn't. So many people have been trying to pick a top since February, and in the end they have probably fueled the rally with their bearish bets.

Now, what about the whole "Sell in May and go away" thing? Well, that has certainly been wise the past three years, as the SPX has peaked the past three Aprils before eventual pullbacks of 17%, 21%, and 11%, respectively. In fact, over the past five years May is the second-worst month, and over the past 10 years it again is one of the weaker months. The big kicker is June, which is by far the worst month.

SPX Returns By Month Over Last 5 Years

SPX Returns By Month Over Last 10 Years

Here's where things get interesting. During Year 1 of the Presidential cycle, May is actually strong! Going back to 1949, May is up 1.00% on average, and is higher 56% of the time for the Dow Jones Industrial Average (DJIA - 14,712.55). (Be sure to check out what Schaeffer's Senior Quantitative Analyst Rocky White has to say about selling in May on the next page.)

Dow Returns First Year of Presidential Cycle

Investors Intelligence recently saw a big surge in the number of participants looking for a correction. Since the '09 lows, when the number gets up to the 35% area, it has actually been a nice buying opportunity more often than not. We are there now, and there's a good chance it could once again show the crowd is too worried at the exact wrong time.

SPX vs II Percentage Looking for a Correction

For some quantified data and a longer-term look at this: Going back to 1980, when those looking for a correction gets over 35%, we do see some outperformance going out six months.

SPX vs II Percentage Looking for a Correction Above 35 Percent

Lastly, here's one of my favorite charts, and it is one I've used many times in the past to remain bullish. I've read a lot that breadth is bad, and this suggests the market is due to correct. Well, if you look at the cumulative return of the advance/decline issues at the New York Stock Exchange (NYSE), it once again made a new high. Historically, this suggests there is actually very strong internals, and it's a great sign that the current rally is on firm footing. I simply don't see any reason to get overly bearish when I look at this chart.

Cumulative Return of the NYSE Advance-Decline Issues

There are a lot of good arguments for both the bulls and bears here. Still, the overwhelming evidence continues to suggest higher prices are on the horizon. Be open to anything, and good luck in your trading.

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