Markets Defy Gravity

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Includes: DIA, QQQ, SPY
by: Wall Street Sector Selector

Everyone is familiar with the old saying, "what goes up must come down."

Certainly the stock market has mounted a serious challenge to this old saying since bouncing off its lows in March and continues to defy gravity.

So now the question is, "What goes up must come down - or does it?"

In the face of unrelenting bad news, the market has been climbing because the news is "less bad," Gentle Ben and his Merry Band of Feds see "green shoots" and the financial press continues an unrelenting mantra of "recovery lies just ahead."

It seems like the markets will never stop climbing, but they will, because contrary to what you hear on CNBC and read in the financial press, the laws of gravity have not been repealed and it's still true that "what goes up, must come down."

The only uncertainties are when and where and how far.

The View from 35,000 Feet

Here's where we stand today:

In this chart of the S&P 500 after Friday's close, several things become immediately apparent.

At the top, the 14 day RSI shows the index approaching overbought levels at 68.18, with "overbought" traditionally considered to be 70.

At current levels we are hitting the lower blue horizontal line which marks a significant resistance level and just above that is the red descending 200 day moving average at 954, another significant resistance level. And just above that, another significant band of resistance between 950-1000.

So the market is overbought, there is significant resistance ahead and we are also entering the "six worst months" of the year according to the "sell in May and go away" philosophy of investing.

If the major indexes can breach these levels, and hold them, most technicians would say that the bear market is over. If not, then at least consolidation or more downside and perhaps even another test of the March lows could be expected.

Sell in May and Go Away?

It turns out there is a body of research that supports this theory and one of the best sources of information on this subject comes from "Stock Trader's Almanac" which actually has developed a trading indicator based on this seasonality and the historical returns it has generated.

Let's take a look at some of "Stock Traders Almanac's" findings:

On a historical basis, the research indicates that the market generates better rates of return from November through April than from May through October. And the difference is significant.

Over a 60 year period, if you had invested on May 1st and closed your position at the end of October, you would have lost money. On the other hand, if you had invested only in the "six good months" you would have made money over the same time.

Now of course, there were years when this seasonal indicator didn't work, but it does appear to offer a significant edge in risk management and investment returns.

Panic Selling Followed by Panic Buying

In place of the panic selling we saw during the first quarter, culminating with the March lows, we are now seeing panic buying that has zoomed the markets up to perhaps unjustified or unsustainable levels. As we move into May, the market continues to face many downside risks; in my opinion, these factors plus the May seasonality mean we're entering a dangerous period in the course of this bear market.

Therefore I believe it's quite likely that we'll see another leg back down sometime during this "worst six months" that now lies directly ahead.

With corporate profits down between -35% and -50% year over year depending upon whom you read, unemployment forecast to rise to greater than 10% in the months ahead, and a fundamental shift from spending to saving by the consumer, a potential crisis in commercial real estate looming, and the money center banks needing "only" $75 billion to remain solvent, it's hard to make a case for robust growth and expanding earnings in spite of the jawboning from the Fed and the financial press.

But in spite of what seems "logical," we must remain agnostic about the future. Instead what I'm going to do is follow my indicators and try to capitalize on opportunities, whether they be long or short, that will be coming along in the days ahead.

The Week Ahead:

Tuesday: March Trade Balance, April Federal Budget

Wednesday: April Retail Sales, March Inventories

Thursday: Weekly Jobless Claims, April Producer Price Index

Friday: April CPI, April Industrial Production, May Empire State Index, May Consumer Sentiment

Sector Spotlight:

Weekly Leaders: Singapore (NYSEARCA:EWS), Financials, (NYSEARCA:XLF) Mexico (NYSEARCA:EWZ)

Weekly Laggards: Technology (NYSEARCA:XLK) Bonds (NYSEARCA:TLT)

I was in London this week where the traditional British gloom is giving way to spring, and believe it or not, their economy and budget problems are worse than ours.

Wishing you a great week wherever you may be.

Disclosure: None

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