Goldilocks Fends Off the Three Bears for Now
By Jeffrey A. Hirsch
Stocks have staged an impressive comeback the past month in the face of a troubled backdrop of world events. Before the nation began mourning the tragic loss at Virginia Tech, Don Imus’ controversial remarks pushed bigger issues off the front page.
Conditions in Iraq have not improved and arguably worsened as the supposedly safe green zone in Baghdad and two major bridges have suffered major attacks. Least we forget, more carnage today in Baghdad claimed scores of lives and wounded. Most disconcerting is the recent Al-Qaeda terror activity in Algeria.
Bipartisan gridlock holds sway over Washington. Congressional Democrats continue to hound the White House for answers on alleged Justice Department improprieties, for changes in the war in Iraq and anything else they can come up with. The earliest Presidential campaign in history has the parties and the politicians vying for distinction and focusing less on pressing matters of state.
However, the market has responded positively to the slew of mixed, yet net positive data released, including first quarter earnings. The Fed’s battles against inflation and recession rage on. Despite a minor one-month increase in housing starts, whether or not the housing recession is over will become more apparent with actual sales readings over the next few months of prime home buying season.
An increase in manufacturing activity last month was encouraging. Headline CPI and PPI numbers showed an increase in prices again, raising the Feds concerns. Even the conveniently stagnant core numbers showed inflation above the Fed’s target zone. Energy prices increased the most and will likely continue to pressure overall inflation higher. Paradoxically, this desired soft landing in the U.S. has weakened the dollar as overseas growth remains stronger.
Measured against previously reduced estimates and guidance, several earnings reports have “surprised” higher. Big cap financials, energy, utilities and consumers have performed best, buoying the S&P and Dow to new highs. The S&P 500 has hit a new 2007 high and is within 4% of its all-time closing high. The Dow is at an all-time high and has authoritatively reclaimed its 50-day moving average [1] after a quick double bottom last month. First quarter data in the tech sector has been less impressive, leaving NASDAQ lagging. It’s hard to see this bull market or economy really taking off to a new level without tech leadership. Further gains of 5-10% look most likely right now as the S&P 500 is drawn toward its all-time high. However, this may be the calm before the storm. As seasonal forces turn negative over the next few months any disappointing data, especially from the real estate market, could bring the house down.
Worst Six Months
May’s recent strength (as well as October’s) and a few decent Worst Six Months in the past four years have inspired this month’s Proving Grounds on the potential shifting seasonal landscape. The jury is still out on whether this is the effect of bull market bias or a genuine change in seasonality perhaps due to the increase in market participants, the Internet age and the global homogenization of cycles.
For the Best Six Months so far the major benchmarks are up about 6% since the end of October and 9-10% from the MACD signals that triggered in the first few days of October. Our ETF positions are up about 3-4% from our December 13 entry date.
We have been on MACD Sell Signal watch for the Dow and S&P since April 1. (The NASDAQ watch does not commence until June 1.) The MACD Sell indicator remains positive [2]. The two lines continue to rise and move apart. When the black MACD Line crosses below the blue Signal Line we will issue an Email Alert.
Pulse of the Market
Market breadth has improved with advancers ahead of decliners the last two weeks [3], though there is room for improvement. For the market to gain more traction advancers will need to expand or stabilize. New highs have also picked up while new lows have abated. [4] This will also have to continue for the market to move much further to the upside.
Sentiment has become more favorable with the CBOE Put/Call Ratio peaking at 0.84 [5] the week after the market’s recent low. This is a relatively high level of fear that would indicate a rally, but nowhere near the extremes of 1.00 associated with major bottoms. Investors Intelligence % Advisors Bullish/Bearish have also eased out of the bearish zone and the American Association of Individual Investors shows bulls and bears about even. Yield spreads are the best they have been since October [6] , reducing concerns of recession and expectations of an imminent rate cut.
May Almanac For a month that begins the “Worst Six Months” there sure are quite a few bullish days—nine to be exact—in the May Strategy Calendar on page 16. This is heavily impacted by the recent 21-year time frame we use, which includes much of the super-bull run from 1982-1999. A longer period back to 1953 after Saturday trading ceased (page 123 Stock Trader’s Almanac 2007) erases most of the bullish days, registering only three on the 2nd, 3rd and 31st.
May is a fickle month. Years ago, this month acted as the lead jab of the one-two punch we referred to as the “May/June Disaster Area.” From 1950 through 1984 May and June combined for an average S&P 500 loss of –0.8%. This two-month loss widened to –1.6% from 1965 through 1984, which spanned the market’s last extended secular bear cycle. May accounted for the entire loss in both periods while June was barely able to eke out negligible gains.
In the early years from 1950 to 1964 the S&P was positive in May ten of the fifteen years, averaging a small gain of 0.3%. June was more of a trouble spot then, down eight times and averaging a loss of –0.04%. But during that long, troubled twenty-year period from 1965 to 1984 the S&P 500 suffered losses in fifteen Mays and averaged –1.6%.
Then the tables turned and from 1985 to 1997 May was the number one S&P month, sporting a thirteen-and-zero record and an average gain of 3.3%. Over the last nine years since 1997, the market has been sporadic in May with the S&P down five for an average loss of –0.1%. May has been just as erratic in Pre-Election years, but strongest for NASDAQ, as it is in most years. This contributes significantly to NASDAQ’s “Best Eight Months.”
May’s first trading day has been particularly strong recently, up seven of the last nine years. Mother’s Day and expiration day can have a positive effect. With the prospects of honoring the ones who raised us, the Dow has risen eight of twelve years on the Friday before Mother’s Day, and ten of twelve on the Monday after. This year it is also the Monday before expiration, which has logged seventeen Dow gains in nineteen years. However, expiration Friday is less sanguine with the Dow up seven and down seven since 1993.
Friday before Memorial Day has been dismal in recent years in quiet trade— except for solid gains in 1997 and 1999. The shortened week after Memorial Day has weakened over the years. After being up twelve straight 1984-1995 the Dow is off seven of the last eleven years, though outsized gains were scored in 1999, 2000 and 2003.
There are no bullish sector seasonalities that begin in May, but the favorable period ends for Cyclicals, Materials and Transports. In the ETF Corner on page 10 we remind you to exit our iShares Dow Jones Transports (IYT) position into any early month strength.
However, we do recommend a new ETF, PowerShares DB Agriculture (DBA). DBA holds relatively equal positions in corn, wheat, soybeans and sugar. Ethanol has rustled up the farming industry in the USA and around the world, affecting these four crops most. Additionally, our trusty Commodity Trader’s Almanac reminds that May is an opportune time to be in Sugar.
1987 v. 2007
Two weeks ago in our weekly Email Alert we again brought to light some of the eerie similarities between 2007 and 1987. Both Pre-Election years followed two previous years without a bear market. Stocks went on a tear in 1987 before the famous crash of October 1987. But what many forget about 1987 was the innocuous 8% pullback in the Dow from April to May much like the recent 6% selloff from February to March.
You can review the other similarities and differences in the Alert archives on the web. But one thing we’d like to add that is clear in the two accompanying charts is that the distance the market traveled in the three years from the 1984 low to April high in 1987, over 120%, towers over the 31% gain from the 2004 low to the recent February high.
We continue to feel that any further upside in 2007 will be much more reserved than 1987 and in line with our 2007 Annual Forecast. Our forecasted 2007 highs of Dow 14000 and S&P 1600 may be reached before any significant decline, but it is more likely that NASDAQ will achieve our forecasted level of 2800 much later in the year after a more substantial pullback.
Please Trade Carefully.
Jeffrey A. Hirsch, Editor
For more information, please visit StockTradersAlmanac.com
AI
Market Data 
Markets 
