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Didn't Sell in May? You Still Might Want to Get Out Now

Wednesday, 17 Aug 2011 | 3:02 PM ET

If you chose not to take the advice to sell in May and go away, you missed the hands-down trade of the year. But there's still time to act, because more selling likely awaits.

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A CNBC.com report on April 19 advised that the popular market maxim would be in full gearfor a market that was "setting up nicely" for a big sell that soon commenced after the May 2 highs.

Back then, Walter Zimmerman, chief market strategist at United-ICAP, cited a "perfect storm" of factors coming together, an "embarrassment of riches for potential things to go wrong" that would trigger a major selloff that would last until at least November.

Zimmerman got his storm: Accelerated fears of eurozone debt default contagion, terrible news on unemployment and housing, and a vicious political battle over raising the national debt ceiling , all of which conspired to send the averages nearly into bear market territory.

On Wednesday, Zimmerman stuck to his thus-far prescient forecast and said he expects more damage to come.

"The economic indicators are unexpectedly bearish from all quarters," he said. "So the reality is starting to set in that this is more than just a little soft patch. When and if the market takes out the lows from earlier this month it will really start to sink."

The Standard & Poor's 500 hit its 2011 peak on May 2, when it was up more than 8 percent for the year. From that peak to its Aug. 8 trough, it fell nearly 18 percent, a bit shy of the 20 percent needed for a bear market. The average has since rebounded about 6 percent.

If the market didn't have enough to worry about, it now faces two of the worst months of the year—September and October—that will collide with a series of technical factors to make gains tough to find.

The recent rebound in stocks has found only scattered converts. Many dismiss it as a relief rally that soon will fade.

"Investors should brace themselves for a bumpy ride as expected volatility—based on daily closes or intraday high/low spreads—is likely here to stay," Sam Stovall, chief equity strategist at Standard & Poor's, wrote in a note.

Mark Abeter, chief technical strategist at S&P, is predicting a surge in volatility and "a new bear market once this relief rally has run its course." Should projections hold of a bear market—or a drop of 20 percent from the most recent highs—volatility levels have far more to rise historically, conversely suggesting that stocks have farther to fall.

"A sharp correction like the current one is followed by a relief rally and then a retest of the lows," George Dagnino, editor of the Peter Dag Portfolio Strategy and Management newsletter, wrote recently. "Be patient. Let the market settle down. The US and global slowdown are gaining momentum. This will have a negative impact on profits. No question about it."

Dagnino's comments were contained in the latest report from Investors Intelligence, a weekly report that gauges sentiment from newsletters across the country.

The most recent results show that a bullish attitude among advisors pervades, as those who think the market is going up still outnumber bears by a 46.2 percent to 23.7 percent margin.

But that's bad news for the market. Such surveys historically have been contrarian indicators that, when at elevated levels, often suggest a move in the other direction.

"So far the advisors have avoided the needed shift to a negative outlook that we associated with a major market setback," said John Gray, co-editor of Investors Intelligence. "The still-low level for the bears is one of the major factors that is keeping us cautious, with projections for only the initial stages of setting a market bottom."

Gary said market correctionsgenerally don't end until the bull-bear spread gets below 10 percent.

So is there anything to look forward to in the battered market?

According to Stovall's research at S&P, markets have fallen a total of 5 percent or more in a single week 39 other times since 1950, and the S&P 500 was higher a year later by a median of 18.5 percent and was positive more than three times in four on average.

He also pointed out that the S&P is trading at a sharp discount to trailing earnings results. Finally, he pointed to the recent drop in consumer sentiment, saying that each time the University of Michigan survey fell below 60—it is at 54.9—the S&P 500 was higher by a median of 20.7 percent a year later.

Talking Numbers: S&P's Resistance Level
Discussing the potential breakthrough level for the S&P 500, with Jeff Weiss, Tejas Securities Group.

Cautious investors thus far have touted the benefit of small-cap stocks, but concern remains over the market's big names.

Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles, said the current environment reminds him of the late 1970s and early '80s when investors were being chased from the market.

"In every selloff investors are selling equities, then they buy into rallies but not as much as they sold," he said. "You're getting a period where you're gradually whittling away at equity exposure and it's all setting up for the next secular bull market."

Flam said he thinks unexpected good news out of the US or European economies will help turn sentiment and get investors back into the market once the current correction runs its course.

Until then, the continuation of sell-in-May could send even more investors out of the market.

"There's nothing wrong with being on the sidelines during a bear market," said United-ICAP's Zimmerman. "You have to adjust your thinking from return on equity to return of equity. You have to make safety a priority."

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