A Down Week

For the first time in a long time the markets did not go up for the week. The Dow Jones Industrial Average lost 1.8%, the S&P 500 dropped 2.6%, and the NASADAQ finished down 2.75%. The loss broke an eight week winning streak for the Dow and the NASDAQ.

Nevertheless, all the major indices finished the month of April up between 1.5% and 2.5%, and all three averages have closed positive 12 out of the last 14 months. It is a rare through market history that we have had successive monthly positive returns like the ones just experienced.

According to “Stockmarket Cycles,” the Dow has risen on 41 of the past 55 trading days. They note that such a sequence has occurred only three times in the last 70 years. Going forward it would seem unusual for the current uptrend to continue. So what does the future hold? According to the Fed’s FOMC announcement they were a bit more upbeat about the economy but said they will continue to keep interest rates low for an extended period of time. That made traders happy from the major banks that are borrowing money for virtually free and giving it to their trading desks to drive up the markets and line their own balance sheets. Additionally the Investors Intelligence Sentiment Index is at 53.3% bullish, and an extremely low 17.4% bearish. That’s the lowest level of bearishness since 1987.

It is imperative to remember that market sentiment is a contrary indicator. A high level of optimism was what was happening at market tops in 2000 and 2007. When the majority become too optimistic it is not a positive sign, but instead a warning sign. When virtually no one is bearish anymore that is usually when trouble breaks out. Conversely if everyone is bullish, who is left to buy? The greater fool theory hasn’t gone away.

Then where will trouble come from? It would seem strange that Greece would suddenly be the black swan to hit markets when it’s been in the news for months. It’s even stranger that the downgrades from the rating agencies of Greece, Portugal, and Spain’s sovereign debt would cause such a panic as it did this past week. I am surprised investors ascribe to anything that the rating agencies have to say about anything. Haven’t investors been paying attention to the bubble brewing in global sovereign debt for a while now? It is amazing that we are attempting to solve the debt crisis by increasing debt. What can possibly go wrong with that solution?

Perhaps the trouble will come from the financial reform bill rolling through congress. Maybe they will finally force major banks / brokerage firms to apply the “Fiduciary versus Suitable” standard to their advice going forward and enact the “Volker Rule” which would force a separation of traditional banking from investment banking. There was some interesting testimony on display this week from several members of Goldman Sachs to that end where they displayed a lack of fiduciary standard towards their clients. Also the recap of earnings from Goldman’s traditional banking profits versus investment profits was telling. Not much lending going on over there to help small businesses create jobs. Oh that’s right – that’s not what they do.

The next weekly pattern is that the ‘monthly strength period’ which will run through next week. It is the time that a tremendous amount of retirement money flows into the markets from employee and employer contributions. One final note is that the “Sell In May and go away” historical adage now comes into play. The long term track record of using May as an exit signal and not reentering the markets until November, takes effect on Monday. While this tendency has a great track record, it should be noted the market does not own a calendar.

It is important to use a sell discipline and tight stop losses at this time. Bears expect a double-dip recession now that government stimulus efforts are being removed and inventories have returned to normal. Bulls obviously feel that the coast is clear. I frankly am worried that a new problem will develop and knock the market down a notch. This oil problem off the Gulf of Mexico and the administrations halt of new drilling could be a catalyst. Be careful of the devil you know but be looking for the devil you don’t know, as that is the one that usually gets you.