Stock Market Rally Fatigue, the Sell in May and Go Away Mantra?

By: Paul_J_Nolte

The mantra, for lack of a better term, is to sell in May and go away. While over the history of actually tracking this simple investing system it has done rather well, it has suffered some recently. Given the huge run in stocks over the past few months, will cash be a better investment than stocks over the next six months? The lass bad economic and earnings data was enough to push stocks up for the seventh of the past eight weeks and gave investors reasons to hope that the economic downturn may actually end later this year.

Our biggest concern about the future of the economy centers on real estate and the banking system. We are seeing very little in the way of home purchase activity as real estate prices as well as mortgage rates fall. Banks are holding onto a fair amount of property that has been foreclosed, but not yet put out for sale. In addition, with the recent earnings releases, little was put away by banks for loan losses in the future. Banks don’t seem too stressed about their tests!

We are beginning to see signs of fatigue in the markets – as the averages push higher the momentum and overall volume lacks the initial fervor of mid-March. So a break is warranted, but will the markets get it? One way to take care of this “over bought” condition is to move sideways for some time, allowing the over bought indicators to get back to reasonable levels without damage to the market averages.

Or, the markets may just keep going – staying in over bought territory for longer than investors believe is possible – forcing them to buy at ever-higher prices. If the markets recover half of the decline from the October ’07 highs would put the SP500 at roughly 1080 – another 200 points (and another 22%) from Friday’s close. Another likely target would be the 950 area, which marks roughly one-third of the decline from May ’08 and the 200-day moving average. The next few weeks could be interesting as historically May starts out just fine, but ends up a mess!

After touching 3% last week, the 10-year Treasury bond yields kept on rising (and prices falling) and closed out the week at just a smidge over 3.17%. What makes this all the more interesting is that the bond model remains bullish, indicating that yields should be falling. Short-term rates are stuck, longer dated maturities are rising (likely due to the heavy debt issuance by the government), which actually makes the banking sector a bit healthier. (Providing low rates on short-term CDs and charging higher rates on long-dated loans) What worries us this that the bond market foretold of troubles in the stock market – could the backup in rates be warning of either a stronger economy or inflation?

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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