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Jeff Saut: Sell in May and Go Away?


Weighing the market's chances.


Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

It takes 8 hours and 40 minutes to fly from Amsterdam to Atlanta. To be certain, that is enough time to contemplate the various market events since I departed a few weeks ago. My parting words of advice were scribed on 5/12/08 in a report titled Throw Deep. To wit:

Sometimes you 'throw deep,' and sometimes you 'grind it out.' We were cautious entering 2008, fearful of the envisioned 'selling stampede,' but turned bullish at the late January 'lows.' Again we were cautious at the February 'highs,' suggesting that a re-test of the January 'lows' was in order. Yet we were aggressively bullish at the subsequent downside re-test of those January 'lows' in March, believing said re-test would be successful. And, that the ensuing rally would carry the major averages above their respective February 'highs.' Regrettably, once again we are cautious now that we have entered our cluster of topside 'timing points,' as well as our upside target zone between 1420 and 1440.

Eerily, on the following Monday (5/19) the S&P 500 (SPX) peaked at precisely 1440 and quickly shed roughly 5%. The swoon left the SPX in the low 1370s, where it was in a near-term oversold condition, as well as testing its 50-day moving average (DMA). Accordingly, the snap-back rally from that 5/23/08 reaction low should have come as no surprise. The question now becomes, "Is the recent rally the beginning of a significant upside move, or is it merely a throwback rally with more to come on the downside?"

Unfortunately, the recent rally seems to be more of a withdrawal of selling-pressure rather than earnest renewed buying power. This is reflected by the fact that in the Operating Company Only Advance/Decline figures only 2.6% of the NYSE-listed domestic common stocks are at new 52-week highs, while more than 51% of stocks are down more than 20% from their respective 52-week highs. Clearly the oversold condition that existed a few weeks ago has been alleviated.

Moreover, the two 80% Downside Days (points and volume on the downside) that occurred during the recent decline failed to be offset by any of the ensuing Upside Days, which registered only a 62% reading on the Upside Days, according to the astute Lowry's Service. Additionally, the SPX's 20-day "low" was breached to the downside in the recent correction (read: negative); and, the SPX was unable to sustain above its 200-DMA. Also, the SPX remains below "The Snake" (aka the 20-month moving average), referred to in my missive dated 5/12/08 (see the addendum at the end of this missive). All of this leaves the technical picture somewhat sketchy.

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My current caution is compounded by the yield-yelp of the 10-year T'note, which broke out above its 200- DMA in my absence, implying higher interest rates. I think longer-dated Treasuries are a sell and those wishing to hedge their fixed income portfolios against higher rates have a couple of new closed end funds with which to do so (for further information contact our Closed End Fund department). Verily, higher interest rates have profound implications for various asset classes. And that, ladies and gentlemen, is another reason I have, after seven years of steadfast bullishness, recommended reducing/rebalancing stuff-stock positions (read: energy, timber, cement, etc.). While longer-term I remain bullish on "stuff," with rising interest rates the "cost of carry" to own commodities increases. That linkage was potentially reflected in crude oil's downside reversal during my travels.

While I remain a long-term energy bull, if crude breaks below $120/bbl., professional money will view the recent parabolic price high of $135/bbl. as a near-term peak. As stated, despite these concerns I remain bullish on select energy companies. Last week that strategy was rewarded by Penn Virginia's (PVA) discovery in the Haynesville Oil Shale region, which rallied my stock recommendations playing to Haynesville (for further comments/ideas see our fundamental analysts' reports).

Turning to the economy, amazingly just a few weeks ago the media was rife with comments that the U.S. economy was heading toward a recession of biblical proportions. I, however, maintained my staunch belief the economy would skirt "your father's typical recession." Recent data tends to confirm that belief with employment, consumption, inventories, profits, etc. coming in on the stronger side. To my way of thinking the question now becomes "Is the economic slowdown "L-shaped," (down and flat), "V-shaped" (shallow with an economic acceleration driven by the monetary/fiscal stimulation) or a "W" (economic acceleration in the near-term followed by a double-dip slowdown a few quarters from now)?" I think a "W" scenario is the potential economic pattern for the balance of 2008 and 2009.

Indeed, certain finger-to-wallet indicators suggest the government-induced economic stimulus is going to over-stimulate the economy in the short term, leading to a torque-up in the inflation rate, which likely will be followed by a rise in interest rates that should slow the economy; aka, the double-dip, or "W"! Manifestly, many broader measures of inflation are significantly above the yield on 10-year Treasury Notes, rendering a negative "real" interest rate environment, as well as negative "real" returns for Treasury Note investors. This means inflation should continue along an upward trend for the next few years, because historically it takes about two years for monetary policy to achieve its maximum impact on inflation. I don't think it will be any different this time.

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