Sell in May and Stay Away?

So last year, we all got our guts kicked out by the sudden correction in the market last year around this time. The FED raised interest rates by 25 basis points and that sparked a market wide sell off. With inflationary pressures rising and oil prices peaking, the economic conditions seemed bleak. We all know what happened to our stocks then. Noise in the media was at fever pitch levels regarding the demise of the stock market.

Fast forward 12 months and we are at the very uncomfortable May, a month of demise, a month to sell and lock in your gains until October. A time to let the boogey man take control of the stock market. Has anything changed since that time?

Well, yes.

It is said that the stock market is always forward looking and the current stock price reflects future events. Kind of cheesy but before you jump to conclusions hear me out. The market as a whole is thought to price in the future. It is uncanny. So, the price that you pay for your stocks today is not necessarily the reflection of recent earnings report or the current events but forward looking future possibilities. Is the market always right? Of course not. But upon review, the market is eerily efficient in this regard. But there are dislocations and as traders we try to capitalize on this aspect in most cases.

So where am I going with this? I think the general media is wrong.

Historically speaking May is a month of tough market conditions where corrections happen. This is why the saying "Sell in May and Stay Away" started. On Marketwatch.com, Michael Ashbaugh's article http://www.marketwatch.com/news/story/could-one-time-not-sell/story.aspx?guid=A5F0934F-EA5C-47E8-9A45-2E4AA39BD1FD&dist=SecMostRead supports my thesis. That is, perhaps this May is a bit different from historically proven adage. I know that statistically I am perhaps an outlier. I also know that since 1950's if you invested just $10,000 and not invested a penny more since and avoided buying in the month of May, the stakes would be worth over $500,000 today. On the other hand if that same $10,000 was invested in the month of May, that stakes would be just over $9,000. So, am I crazy?

Perhaps. This market has me baffled as the economic sentiment is resoundingly bearish. I too feel bearish but have chosen to obey the technicals of the market with the exception of Countrywide (read my other blogs on this topic- I am tired of beating a dead horse). That is I am technically bullish on this market. Why? Is it because I got burned by Countrywide last month? No, but that memory still lingers and is painful. It is because when I review what happened last May, it is highly correlated to the current market fundamentals. In May 2006, the market was hoping for a rate cut but instead got a rate hike, which sent the market over the edge. But was that the catalyst? When you dig deeper, it appears that May 2006 was looking ahead to May 2007.

The months following May 2006 was down right scary. High fliers such as Google, Apple, Coach, and many others were simply taken out to the shed and shot. Apple was trading almost 50% off its highs at that time. Oil prices kept climbing and climbing. Hurricane season in 2005 had left an indelible mark on the psyche of the stock market. Many were not even factoring in a recession. By the way, recession is probably over as you read this blog today. That is because when all the market fundamentals appears to be going to the outhouse, that is when the market has recovered. It is just that the indicators of recession is a lagging one by about 6 to 8 months. Having said that, is it possible that the markets have been pricing in a economy that will recover in 6 to 12 month time? Recession is all over the news media and I am also guilty of that over the past few months on this blog. It is just that I had a epiphany agonizing over the apparent dislocation of the market fundamentals and technicals.

At least this way I am able to explain the market fundamentals and the apparent rally in the stock market that seems to keep charging ahead. This thesis is by no means complete. I do know that the small caps have not participated at all in this rally and that the advancers to decliner ratio was actually bearish in most cases. But be as it may, I am a price to volume guy and I tend to discount many other technical indicators which are mostly lagging.

Housing will continue to drag on this economy but I believe the market has essentially priced in the worst case scenario for the majority of the market. This does not mean that the housing related stocks and mortgage lenders are in the clear. They will yet feel the sting of the market. But like I said, the actions that we saw in the past month does not happen at market tops. Clear and simple.

I think the great barometer of whether this market rally will continue will hinge on the FOMC meeting next Wednesday. I believe that the FED will continue to remain neutral with some hawkish posturing. But I believe the FED is a toothless tiger in this case because they can't do anything without causing some harm. Catch 22 my friends, Catch 22. They can't raise or lower rates but if pressed, they will raise rates rather than cut. You can take that to the bank.

So why do I think that the markets will not sell off in May 2007? Because we have worked off the excess in February 27th through March 21st. It was a short lived correction and I still remain weary of the follow through day but a rally of this magnitude with indices breaking to new highs despite my sentiments to the contrary, states that the market knows something I do not. I would however throw caution to the wind and say that if the rally continues through May and the summer, likelihood of a market meltdown in October remains high. Especially if the market is wrong now, which I tend to agree it is. I just choose to follow the trend.

Good luck and be careful out there!