Just 10 days ago, we wrote an article on the PowerShares QQQ Trust (QQQ). In that article, we wrote about the signs we saw of a pattern change coming. We spoke about the seasonal movement and mentioned the colloquium: "Sell in May and Go Away." We also looked at the charts that showed severely overbought positions and a negative divergence in the MACD. We have had five straight days of bearish influence. Now investors are wondering if this is the beginning of a bearish cycle in the market.
Does Oversold Stocks mean Bearish Market?
Bespoke Investment Group wrote in a brief article on Seeking Alpha about an important observation in the market. It appears that we have the (click to enlarge) the highest number of 'oversold' stocks since October. I have attached the chart that they used. But there is another observation I would like to make as we look at this chart.
When the chart has shown that overbought stocks influenced the market, the market would rise. When oversold, the market would regress. On this daily chart of the QQQ one can see the areas in purple that coincide with the times the market was overbought. This oversold indicator is a fairly accurate sign of a possible downturn in the market again. Therefore, this 5 day dip might not just be a short-term movement, but the beginning of something bigger.
Inflation Fears Ahead?
With the increase in petroleum prices, we are also seeing an increased cost in our imports. U.S. import prices climbed by 1.3% from the month before; it was the largest monthly gain since April 2011. There was an expected gain of 0.9%, but this surprise was 40% higher. Even though this gain was not as bad as a year ago, the Feds warned that this increase could also push up inflation temporarily.
If the inflation rate is high, interest rates also go up. In the wake of both (inflation and interest rates) being high, a creditor will have a tendency to compensate for the rise in interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant role in preventing funds from being invested in the stock market. Thus, there is a good chance markets could go down with the inflationary cycle.
Government bond worries in Spain and Italy resurfaced, as a lack of interest in the bonds make investors leery of the ability to pay them back. Continued protest in Greece with the bond weakness opens the door to European debt worries again. China has been reporting a slowdown in the economic climate as imports grew less than expected. In the U.S, earnings this quarter are not expected to be glamorous at all. Expectations are very low for this quarter's earnings reports.
Between the oversold market, short term inflation fears, dismal earnings expectations, tension over European debt and a slowing Chinese economy, the phrase "Sell in May and Go Away" looks more and more reasonable. We very well could be in the beginning phase of a bearish turn.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.