Sell in May and Go Away?
Could current rally be a massive headfake?
Mark Twain once said history doesn't always repeat but it sometimes rhymes. Investors around the world hope that doesn't again prove true.
We asked last year whether we should sell in May and go away following the spirited sprint off the March lows. In the twelve months that followed, the S&P was sliced in half as a confluence of negatives combined to create the financial equivalent of a perfect storm.
We humbly offered in January that 2009 could see two 20% bear market rallies that litter the landscape with false hope and empty promises. As we digest the initial lift, the obvious question is whether we'll see a meaningful decline before a second such move arrives later this year.
The most constructive possible path at the end of March was a sideways digestion of the gains as a function of time rather than price. That worked off the overbought condition and created (potentially bullish) reverse head & shoulder patterns across the major indices. We must respect that scenario if it triggers with a trade above S&P 875.
Be that as it may, I believe the current rally will prove to be a massive stock tease. We monitored the cumulative imbalances as they built through the years and it would be myopic to assume we've swallowed the bitter pill in its entirety. While there are two sides to every trade, we must remember that social mood and risk appetites shape financial markets.
I don't know how "things" are where you live but through my lens, times are tough and tension elevated. While news is always worst at the bottom and best at the top, our finance-based global economy is dependent on employment, leverage and the velocity of money. One way or another, the bar bill of our collective excess must be paid by this generation or the next.
The big picture is made up of many smaller ones and the destination we arrive at pales in comparison to the path we take to get there. As such, as we gaze across the global horizon, I wanted to touch on five dynamics that should remain on our radar as we find our way through this prickly fray.
When Pigs Fly
As if we didn't have enough on our minds, the specter of a global pandemic adds another layer of uncertainty to an already complicated equation. The World Bank estimated last year that an influenza pandemic could cost $3 trillion, trigger a 5% drop in global GDP and lead to upwards of 70 million deaths.
As we hope for the best, risk management requires that we respect potential contagion, particularly if the specter that the virus was man made seeps into the mainstream mindset.
The Pop & Drop
One of the primary reasons I adopted a more constructive trading stance in March was that we were effectively backstopped against Armageddon. In other words, if General Electric (GE), Citigroup (C), General Motors (GM), Bank America (BAC) and others simultaneously failed, paper losses would have been the least of our worries.
While healthy skepticism of further upside remains, there is widespread acceptance that a breakout above S&P 875 would clear a path towards the 200-day moving average at S&P 970. As such, clearing that technical hurdle would clean out the shorts and potentially set the stage for a vicious head-fake.
One of our Ten Themes for 2009 was the evolution of societal acrimony to social unrest and geopolitical conflict. The world stands at a critical crossroads, with orderly debt destruction and eventual globalization on one side and isolationism, protectionism and the unfortunate truth that all world wars were born from economic hardship on the other.
With the Taliban sixty short miles from the capital city of Islamabad, we would be wise to keep this nuclear state on our radar.
He Said, She Said
The back-and-forth between embattled Bank America CEO Ken Lewis, Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Hank Paulson has massive implications for the psychology surrounding the government's role and responsibility in the capital market structure.
As Minyanville offered in August 2007, "The Federal Reserve attempted to buy time on the back of the tech bubble with fiscal and monetary stimuli that encouraged risk-taking, reward-chasing behavior. While debt is front and center, credit of a different breed-credibility-has emerged as the issue at hand. If and when investors begin to perceive that central banks are no longer larger than the markets, a crisis of confidence will ensue."
The "more adverse" scenario offered by the government-a 3.3% contraction, 8.9% unemployment and a 22% decline in home prices (followed by a rebound in GDP of .5%, 10.3% unemployment and 7% degradation in home prices the following year)-is debatable at best. It's clear that some banks will need to raise more capital (further diluting equity holders) and others won't make it to the other side of this prolonged socioeconomic malaise.
I, like most of you, stand to benefit from an economic expansion that buoys our spirits with the rising tide of good fortune. The popular opinion is rarely the profitable one, however, and my hope is that sharing these potential caveats provides utility as we collectively prepare for the future.
Financial staying power, risk management over reward chasing and proactive financial intelligence remain three staples of any successful investment approach.
In memory of our fallen friend and trusted colleague, Bennet Sedacca, 100% of the donations made to the RP Foundation through April will be channeled to philanthropic endeavors consistent with the RP mission, working closely with the Sedacca clan in the distribution of those funds. We thank you kindly for your support as we strive to effect positive change in the lives of children.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at email@example.com.
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