There is an old saying of “Sell in May, and go away”. A recent study from Ned Davis Research showed that since 1942 if one had invested $10,000 in the S&P 500 during the October to April period they would now have $933,239. If on the other hand they invested from the May to September period they would only have $12,839. A dramatic difference!
Since the market made a high volume climactic low in July 2002 we have witnessed a series of sharp ups and downs that numerous pundits have been saying is the final bottom. Of course in a real bear market there will be only one final bottom and at that point in time there will be nary a bull to be found. Today we still have too many bulls especially amongst some analysts and fund managers. While the public may be wary the pitches coming from the sell side of the street, while more subdued, is still strong today despite three years of a bear market. And that is despite the fact that numerous analysts have faced disciplinary action including substantial fines (which was only a pittance compared to what they made or earned during the late nineties bull market). That alone tells us that we are nowhere near the final bottom in this bear market.
Of course when one sees the bleeding in the mutual fund industry with almost a year or more of ongoing withdrawals it is easy to understand why the funds continue with soothing pitches. But while we have been down now for three years there are many pitching that the market could never be down four years in a row. Of course what they won’t point out is that Japan has now been down for thirteen years and counting and it is still making new lows. Of course Japan had numerous counter rallies over the years again with each one of them hailed as the final low. And counter rallies can sometimes be impressive. Since the top three years ago we have had at least a half dozen including some of more than 15%.
The current series of rallies since last July have made it a difficult market for investors. Traders may have capitalized from the volatility but it can also mess with traders if the market changes suddenly. But these rallies, while impressive, have been overall feeble. There definitely seems to be a wall on the S&P 500 at the 950 level. Since this is the third approach near these levels many believe that triple tops are rare and we are poised to breakthrough. Of course if we ever took that level out then the market might get really excited and start a more broad based rally. But that is not likely as once again the market has rallied into serious resistance zones and the volatility VIX indicator has plunged into a major sell zone. Volume has not been expanding, as it should in the start of an early new bull market although market breadth has been on balance quite good and broad based.
So while the market has been rallying since the last significant low seen in mid-March it has also quickly brought the valuations back into very questionable territory. The S&P 500 Price Earnings (P/E) ratio is back over 30 and Internet stalwarts such as eBay, Yahoo and Amazon are at P/E valuations of 88, 105 and 103 respectively. Seems to us what we are seeing is a big counter trend rally back that has now brought in considerable optimism especially with the quick end to the war, the lowering of oil prices and with SARS in remission. This kind of set-up often precedes a big wipe out that will take the market to new all-time lows and at that point maybe even the bullish analysts and fund managers will throw in the towel.
The economic front remains mixed but GDP growth came in below expectations and the unemployment rate while officially reported in the USA at 5.8% is by some estimated more to be in the 11% range because it does not take into consideration those that want to work but have given up. The Federal Reserve has been maintaining low interest rates and money supply growth remains consistent in the 6-8% range for M3 sufficient enough to more than maintain liquidity but still high relative to economic growth. Consumers continue to spend and sentiment has bounced back particularly with the ending of the war.
While all of this is conveniently mixed there are as we have pointed out storm clouds gathering. The most important one is the fall of the US Dollar. It will become important for the US going forward to maintain confidence in the US Dollar despite the massive dueling record budget deficits in trade and on the domestic front. The key here of course might be the ability to maintain low oil prices backed by the military might of the United States and at the same time try to prevent a run into the Euro currency as we are already seeing. Some countries such as Indonesia are on record that they are on the verge of accepting only Euros for oil payments. The US will do what they have to in order maintain the integrity of the US Dollar. But will they succeed?
But the massive deficits of the US are a potential problem particularly in a potentially new bipolar world. We have noted before that trade might be a problem and a recent World Trade Organization (WTO) report expressed grave concerns about international trade volumes that have fallen by half globally since the 1990’s. As well they note rising unemployment globally, lethargic global economies, a contraction in international capital flows by half and the threat to international institutions and agreements because of the military conflict in Iraq and the potential for other conflicts to arise as well as growing tensions between the US on one hand and France, Germany and Russia on the other. As well, while many are optimistic about the “road map” for Middle East peace there are powerful opponents on both sides that will want to see it fail.
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