Market Setting Up Nicely For Sell-in-May to Take Effect

A wobbly stock market facing pressure from numerous sides could be setting itself up as a victim of one of the oldest market dangers: Sell in May and Go Away.

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The trend, in which early gains start evaporating as investors leave for summer vacation and shed their positions, poses danger especially when the market has a fast start to the year. That's been the case for 2011 and its sizzling first quarter.

Combine that with the recent threat of a debt downgradefrom Standard & Poor's, a parabolic surge in commodity prices, and the imminent exit of the Federal Reserve from its liquidity policies — and the inclination to subscribe to the old maxim becomes hard to resist.

"There's almost an embarrassment of riches for potential things to go wrong," says Walter Zimmerman, chief strategist at United-ICAP. "This seasonal impact is an endogenous component of the dynamic of the stock market. It doesn't require an outside cause."

Zimmerman sees what he calls a "perfect storm" of market danger: High stock valuations compared to book value, unrest in the Middle East, and overheated market sentiment further amplify the risks of the other aforementioned factors.

The fears are shared among market bears who feel the flat market of the past seven weeks will become a down market as the sell-in-May trend takes hold.

For the summer, Zimmerman recommends investors turn to cash and cash-equivalent assets such as short-term Treasurys until the selling passes.

"The track record of sell-in-May-and-go-away is so stupendously overpowering that I don't want to be on the wrong side," he says. "Investors want to be underinvested from May until November. They should be on the sidelines."

May historically has been a tricky month for stock market investors, market cliches aside.

Since World War II the month has brought seven pullbacks—more than any other—with a modest return of 0.3 percent, which ranks it eighth out of the year's 12 months, according to Sam Stovall, chief equity strategist at Standard & Poor's.

Stovall's firm created the biggest market stir in quite a while when it warned Monday of a possible cut to its outlook for US debt. The averages lost more than 2 percent at one juncture before recovering somewhat, and were rallying modestly Tuesday.

But the threat of a rating cut is likely to fuel more concern that May could be a rough month.

"There have been a lot of headwinds that the market has been able to withstand and continue forward progress," Stovall says. "But now that we have the downgrade of the outlook for the US and I'm not really sure that earnings are knocking the cover off the ball, investors are probably thinking that maybe we have overanticipated good things to occur during this first half."

What's more, the market has not seemed to price in the end of the Fed's Treasury-buying program, often referred to as quantitative easing.

The second leg of QE, which has entailed another $600 billion in government debt purchases, wraps up in June and will take a sizeable chunk of liquidity out of the market.

Also, the Federal Reserve delivers its next policy decision April 27, which will coincide with the first post-Open Market Committee news conference from Chairman Ben Bernanke, an event that journalists are looking forward to but some investors are dreading.

"The bang for the buck that he got from QE 2 is unparalleled," says Abigail Doolittle, head of Peak Theories Research in Albany, N.Y. "That trick can only be played so many times."

Doolittle sees the market heading for some crucial tests of support and resistance levels that may coincide with the historical May selling period.

"Even though there is some statistical backing to that adage, I don't know that I'd put that much merit in it," she says. "But we could see the market continue to sell off from where we began a week and a half ago."

Key levels for the Standard & Poor's 500 will be about 1,370 on the topside and then around 1,200 on the way down, she says. A breach would signal longer-term movements in that direction.

The prospect of a difficult May could prove a boost to Treasury prices and provide another leg up for commodities, where gold briefly topped $1,500 an ounce Tuesday.

Kathy Boyle, president of Chapin Hill Advisors in New York, says she is hedging equity positions with gold and the Market Vectors Coal exchange-traded fund.

Markets these days are so driven by high-frequency momentum trading that any sustained slide in the market could snowball and accelerate the sell-in-May trend, she says.

"An unexpected event when everything is priced to perfection could be something that really triggers quite a big fall and we keep going," Boyle says. "These are computer programs going here, but those guys are not long-term buyers. They are not buy-and-hold candidates. You have a lot of nervous money in here."