Sell in May and Go Away? A look at the Dow since 2001

May 6, 2007: 12:28 AM CST

Many articles have been posted regarding the axiom: “Sell in May and go away,” which is in reference to studies that show that the market’s worst performance begins in May and ends in November. While performance is mixed on various years, it is helpful to study the last 5 years of market action (as evidenced by the Dow Jones) and determine whether this was an attractive strategy in recent history.

2006

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2005

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2004

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2003

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2002

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2001

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Results:

2006: Yes in the short term and No in the long term (would have been better to buy in June)

2005: No. Market highs were made in March and not retested until November

2004: No. Market high was made in February and exceeded in December

2003: Absolute no. Selling in May would have left enormous profits on the table.

2002: Yes. This year would have worked wonderfully to Sell in May.

2001: Yes. Perfectly. The high of the year was made in May and low was made in October.

Cursory results: 50% effective, IF that high.

It is still best to study and analyze the market daily or weekly, and not rely on old market wisdom, at least as it regards to actively trading the market. Investing is not simple – not by a long shot. The profits go to the diligent, not the lazy.

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Declining Dollar, Rising US Stock Market – Danger?

May 5, 2007: 10:00 AM CST

Is it possible the recent year’s rally in the US Stock Market is in part due to a falling dollar and rising inflation, rather than economic conditions?

Consider the following. Many people are ‘bearish’ the US stock market and cannot believe the strength of the creeping uptrend in the US Indexes because they believe a recession is ahead based on various interpretations of economic data and future projections.

Consider also that the US Economy is experiencing inflation readings slightly above the Federal Reserve’s “comfort zone” of 2%, yet economic growth (evidenced by GDP) is slowing, causing some to cry for calls of possible ’stagflation’ ahead.

While this post will not address those issues, consider also the following: The stock market tends to lead the economy by six months, making the market a forwardly anticipating mechanism. The implication here is that the economy will strengthen in the future, yet signs on the ground now are not showing it convincingly.

Finally, consider the possibility that economic conditions are deteriorating, and that the rise from July 2006 to present is due in part by inflation and the declining US Dollar value. The market discounts all known information, which means it discounts these variables as well.

The implication is that, while US indexes continue to make new highs (Nasdaq and S&P excluded), actual purchasing power is declining relative to the new highs in the equity markets. To put it another way, conditions ‘behind the scenes’ are so bad that the inflationary and dollar declining mechanisms built into the stock market are causing the market to rise as a result of the poor conditions, (relative value) while absolute value declines.

Here is an illustration. How would you feel if the US Stock Market suddenly surged 600% this next quarter? Wonderful, wouldn’t you? I bet there would be celebrations nationwide about how wonderful the economy is and how rich we are as Americans and CNBC will be parading all the time.

But what if the inflation rate for the same period was 1,000%? This exact scenario actually occurred First Quarter 2007 in Zimbabwe’s economy. While their stock index made astounding new highs and record-breaking increases, it was a direct result of inflation and little else. Wouldn’t you argue that inflation rates that high indicate a terrible, abysmal economy? So why didn’t their stock market index break to new LOWS instead of record HIGHS? It’s because the market index has to keep up with inflation, and when inflation rises, so must everything else tied to that currency (in terms of purchasing power).

So an apple might cost $1 today and the next month will cost $1,000. Of course, your salary would increase from $30,000 per year to $30,000,000. Would you like to have a salary of $30 MILLION per year? I would! But what if a house cost you $200,000,000? What if a car cost $15,000,000?

Does it make sense now why the Zimbabwe stock exchange gained 600% now? The truth of the matter is that the relative value of the stock market DECLINED precipitously, but you can’t tell that if you’re only looking at the index itself.

The US Economy is no different. While the stock market may be making new highs, is it is partly due to inflation and the declining dollar being factored into the complex mathematics that is the market discounting mechanism.

So while the average American focuses on new price index highs and celebrates, those who look beyond the data realize the meaning behind the numbers and realize we’re in a lot of trouble unless the US Dollar begins to rise and inflation begins to subside.

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US Dollar Index Bottoming?

May 3, 2007: 10:08 AM CST

Here is the most updated weekly swing chart of the US Dollar Index, which is on par to do one of two things: Make new lows or find support & reverse (temporarily).

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Notice the two momentum divergences. We are currently experiencing a ‘buy’ divergence at a place where the market reversed in the past (2005) and odds favor a reversal in price soon from a momentum standpoint (although the trend is quite obviously down currently).

What does this mean? When the dollar (index) decreases relative to other currencies, your dollars can purchase less goods and are less valuable, even above and beyond an inflationary standpoint.

It also means, as others have indicated, that the Dow and Markets making new lifetime highs aren’t as significant as they could be if the dollar index was making new highs as well. The new price highs are less significant because the dollar is worth less.

Envision you found a great, guaranteed investment opportunity in Mexico that would return 30% in a year, and say you invested $100,000 for a profit of $30,000. The only catch is that you had to invest in pesos. When you invested, assume $1 bought 10 pesos. The investment was 1,000,000 pesos for a return of 300,000 pesos. Not bad, right?

Now let’s assume that Mexico’s pesos fell relative to the dollar by a significant amount – 50% (for illustration purposes). Let’s assume that the exchange rate now was only $0.50 for 10 pesos. To put it another way, $1 = 20 pesos. You now exchange your 1,300,000 pesos for US dollars and wind up with … $65,000 US Dollars.

So, even though your investment returned 30% in a year, you are actually DOWN $35,000 dollars because the peso was worth much less by the end of the year.

Of course, this is an extreme example, but realize that the Dollar Index has declined 33.5% since its 2002 high, which means that your dollars are worth about 1/3 less than they were in 2002.

Always cross-check inter-market relationships when determining long-term price and the implications of price on your investments. The Dow may be making new highs, but your dollars aren’t.

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DIA Intraday May 1-3

May 3, 2007: 9:39 AM CST

I’ve posted a chart of the 15 minute action of the DIA (Dow Jones ETF) for a study on momentum divergences.

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This illustrates the buy divergence occurring around noon on May 1st which led to the “Impulse Buy” trade concurrent with the breakout and new momentum high.

The market has ended a buy swing and is now consolidating in price, and subsequent ‘higher highs’ are resulting in momentum divergences, indicating consolidation at best and retracement as likely.

The price action also visually confirms the decreasing momentum (buying pressure) as price struggles to make new highs. Support appears to be at 131.88, but should this level fail, odds favor continuation to the downside. For now, I expect continued consolidation before the all-important “Jobs” report and economic data Friday.

If you’re unaware of this data, realize that the Jobs Report (first Friday of the month) has the potentially to move the market dramatically (sometimes over 150 points in the Dow).  What usually happens before this report is market consolidation as traders are usually unwilling to take positions before the report and often prefer being ‘flat’ prior to its release.

Nimble Day-traders often can profit handsomely from the sudden volatility that occurs as a result of the report, should the numbers differ from consensus.

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Weekly Market Charts – May 2

May 3, 2007: 7:47 AM CST

The market notched another record closing high for the Dow today. Such headlines inspire more yawns than cheers now. Are investors becoming complacent?

Here is a look at the swing chart of the major indexes:

Dow Jones

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  • New Price Highs confirmed by New Momentum Highs. This suggests higher prices are yet to come.
  • Uptrend is solid with regular and (arguably) shallow pullbacks. Odds favor continuation.

Nasdaq

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  • The Nasdaq is showing a different momentum pattern than the Dow.
  • New price highs are NOT being confirmed by New Momentum Highs. This is not comforting.
  • Market successfully ‘tested’ the rising 50 period MA
  • Red “trend” oscillator recently bounced off zero and turned up – a bullish signal
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