Sell in May and go away?

Tomorrow is the last trading day for the month of April and after a 15% uninterrupted rally in the S&P 500 over the last couple of months, the question on everyone’s mind will likely reflect the old adage: “Is it time to sell in May and go away?”

It’s true that seasonal tendencies portray weakness in May, but this is hardly a given. Over the last four years the monthly returns for May have been -6.01% (2012), 2.36% (2013), 2.32% (2014), 1.29% (2015). So as you can see, these seasonal tendencies can be spotty, so it’s best to take a top down approach.

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Currently the S&P 500 is only about 2% off of its all time highs after rallying about 16% in the last two months. While I do believe new all time highs will be achieved in the near future, there is reason to believe that a pullback is warranted. But this is primarily directed at traders/hedgers.

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There are some subtle divergences that are showing up that suggests the S&P 500 may not be able to rocket past these prior highs on the first attempt. One of the simplest illustrations is the recent divergence between Large, Mid and Small cap stocks.

The above chart shows the S&P 400 midcap index which is currently about 5% below its all time highs (even though it’s rallied 20% off the February lows).

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The S&P 600 smallcap index is about 6% away from its all time highs. Usually you would like to see breakouts throughout the three main market caps to confirm a healthy uptrend in place. I do believe it will happen in the near future. But in the near term, this divergence may induce a pause in the broader market. And seeing as though we are headed into a seasonally slow period, I wouldn’t be surprised to see a pullback occur here. And it would be a good buying opportunity, if it were to occur. Recession odds are still relatively low, central banks are still very accommodative and have left investors without much other options for capital growth, now that most savings accounts and treasury bonds have negative real yields.

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Apart from that the technical structure of the market continues to be positive. The above chart shows that the advance decline line of stocks on the NYSE are at all time highs, even though the S&P 500 hasn’t yet made an all time high. This simply means that more and more stocks are participating in the rally.

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Same with the S&P 500 advance decline line….

So while the “Sell in May” pattern may or may not materialize, the internal strength continues and this bodes well for the future.

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But as we pointed out, the potential for a near term correction is very realistic. So what are potential downside support levels? I think the first logical stop would be back to the 2000 level in the S&p 500. This coincides as the 38% retrace level off the February lows and is right around where the 200 day sma currently lies as well. That would mark a 5% correction, which has been the most common size correction during this bull market.

The max downside I see right now is around 1965 on the S&P 500. This would match the size of the 140 point decline from January to February and match up with some prior swing highs and lows as well.

So there is the blueprint. We’ll see how it all plays out.

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