Well, it looks like we dodged the S&P 500 Index at 1,040 sell bullet. The market has bounced nicely from that level and is currently trading at 1,094. I always wonder what it means when institutional investors are all looking at the same charts showing the same resistance and support levels for the market. In this case, 1,040 was truly the last line of technical defense for the S&P to the downside and we have been writing that we would be reducing risk if the market closed below that price. Since everyone else was looking at the same chart, you wonder how much of the subsequent rally was a self-fulfilling prophesy…at least in the short-term.
Where does the playbook go from here? I believe that the same institutional investors who were playing for the rally off of the 1,040 level will now be looking for a classic summer rally. It is well known that the typical market cycle leads to the conclusion that investors should “sell in May and go away.” Perhaps a little less well known is the May sell-off is often followed by a relief rally in June and July. It is when you get to late summer that history suggests that extreme caution is appropriate. History is full of market swoons that begin in August and continue falling through September and October. So, looking at a chart it seems very clear that the current rally could take the market back to its 50-day simple moving average of 1,145, or even back to its April 23rd high of 1,217. If you get there on the rally…it’s time to sell. In a lousy year for stocks, who can afford to give up the next 10% to the upside if you can get in and get out?
So everyone will be playing chicken with everyone else, intently studying the “quality” of this rally (if it continues). In a perfect world we will see a rally in the euro, a sell-off in U.S. bonds and gold, and a return to market leadership in the late cyclicals in the U.S. market, meaning big gains for energy, materials, and industrials. If the rally plays out according to the playbook, then everyone will be looking to sell into it, hoping to catch as much of the gains as possible before we get to the late summer market doldrums and the outright fall market nightmares. The question is, if everyone knows the playbook, and institutional investors are trying to invest the same seasonal strategy while looking at the same market themes and levels of price support and resistance, doesn’t that completely invalidate the playbook? I know that we are cautiously playing for this summer rally. I also know that we won’t be surprised by a completely unexpected market move…in either direction.
