2005 has unfolded quite differently than many expected (us
included). Weakness hit the Markets immediately, with the major indices down 3
of the first 4 months of the year. Might all this market rain beget a blossom
of stock gains? Perhaps, although we suspect that such a flowering will come
from lower levels. More watering, some topsoil and a Wall Street favorite –
fertilizer – just might do the trick.
A variety of both positive and negative factors are
buffeting the gardens. The good news is that corporate earnings have been
robust. Balance sheets are in good shape. There is plenty of cash – both in
corporate coffers, and investor money market accounts – to be deployed. The
price of Crude has eased, and wage pressure is nearly non-existent.
Unfortunately, the flip side offsets many of these
positives. Our biggest concern is the technicals: the huge overhead supply is
of far greater concern than Seasonality issues. The prior trading range –
encompassing the post-election rally, from November to mid-April – now
represents a major challenge. As we have previously mentioned, the formidable resistance
is at Dow 10,400, Nasdaq 1990, and SPX 1165.
The reason this zone may represent a struggle is mostly
psychological: the mid-April breakdown reflects a significant “attitude
adjustment” by portfolio managers. It wasn’t until then that the gradual
recognition of slowing GDP and rising Inflation finally worked their way into
stock prices. We suspect that in order to return to that previous pricier
region, a positive change of similar magnitude is necessary.
Since we mentioned seasonal pressures above, a few words on
that adage might be in order. May has historically been the start of a period
of relative weakness. We would be remiss, however, if we failed to point out
that “Selling in May, and then going away” has not generated positive returns over
each of the past 2 years. Indeed, in 2004, we exhorted traders to “Sell in May
(but Don’t go away).”
I expect we could see a similar pattern this year. The very
oversold condition in August 2004 led to a strong move upwards – but the
markets are not as oversold here. We could see a bounce back towards all that
overhead supply. A failure at those levels would then set up a sell off into
summer. That could generate the sort of panic selling which precedes a muscular
rally into year’s end.
Where does that leave investors? A modest oversold rally
could develop here, but one that is unlikely to crawl back into that prior
trading range. We therefore remain sellers of any move towards the
aforementioned prices. We await more advantageous levels to deploy fresh
Our posture remains “Sell in May – but look to Buy on Independence Day.”