Well, that was entirely predictable. The last trading day of the month combined with a big dud of an announcement from the Federal Reserve and stocks sold off late in the day, Wednesday. Could this be a sign of things to come for the month of May?
I think so. The market has been on a tremendous run since the Bear Stearns (BSC) bailout with April being the first up month in who knows how long.
Noticeable in the rally are two fairly basic technical observations. For starters, the rally started at the approximate low for the S&P 500 first hit in January of this year. Secondly, yesterday’s gains peaked at a key barrier to future gains at 1,400.
If you look at a chart of the S&P 500, one thing becomes abundantly clear in the pattern formed during the course of this year. It looks to me to be a reverse head and shoulders chart.
Now mind you, I am no technician as my background is in fundamental analysis, but I am open to using charts in formulating my qualitative opinions about the market.
In this case, I can say with a high degree of certainty that we have one more leg down here. It was no coincidence that the market rallied off the lows in March, and it should be no surprise when the market bounces off the 1,400 level only to retest the lows one more time.
Unrealistic Market Expectations
It all makes a ton of sense, especially if you consider…> the economic conditions of the moment. The market is not priced in reality. Instead, speculators have established the position that the economic malaise will be short-lived at worst.
While that view may be justified (as I do believe the U.S. economy is diversified to the point of recovering from the housing and credit mess), it seems like a bit of a risky position.
Add it all up, and the ingredients are in place, for some selling here. That does not mean I am negative about the future. Instead, I believe that we need to allow time and distance to do some healing with the economy before becoming more aggressive with our portfolios.
Richard Band in his Profitable Investing journal shares a similar sentiment. As he states, a near- term top has been put in place and the market may simply need to rest and digest from here.
I’m a bit more pessimistic in the near term. I find it fairly amazing that stock values can rise given the very real negatives for the economy. Rebate checks and gas tax suspensions will not cure what ails us.
Fueling the rally has been stronger-than-expected earnings and a realization that the economy is not yet in recession. Indeed, the numbers are impressive, but keep in mind the source of that strength.
Most of the biggest profits are now coming from overseas sales. The weak dollar really helped exports, and that simple fact has kept us out of recession.
Will that trend continue?
I doubt it. The reality is that we are sort of delaying the inevitable. Global growth still hinges on a strong U.S. economy. Without that strength the rest of the globe will ultimately follow suit.
As a result, exports can be expected to slow unless of course the dollar continues to tumble. Ah, but the dollar tumbling invariably creates its own set of problems like inflation.
Again, the headlines to this story may be negative in the short run, but that does not mean we won’t rise again. We will.
It just takes time and given that we have time, not to mention good technical reasons, we should be more conservative with our actions.
Richard Band suggests making a switch from the large-cap equity fund, Longleaf Partners (LLPFX) to the more conservative bond and equity fund, Selected American Shares (SLASX).
When folks like Warren Buffet, John Bogle, and now Richard Band recommend more conservative allocations in a portfolio, I would listen.
There are some very compelling reasons to believe the market may be in for a rough ride in the near term starting with the supposedly very merry month of May.
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