U.S. Stock Market: Sell in May and Go Away?

Some would argue that this tried-and-true stock market seasonal guideline in no longer relevant and not worth the "paper" its written on. These same people would argue that there is only one stock market truism worth following now, and that is "Don't fight the Fed!". Recent evidence certainly supports this view, but I am not ready to completely disregard the negative seasonal period that is about to begin for the U.S. stock market.

It might help to review some of the reasons why so many U.S. stock market averages are now at record highs. In theory, over the long run, stock prices should really reflect corporate earnings now and in the future. Assessing the "now" part is easy. However, the "future" part is challenging at best and nearly impossible at worst, especially if we look out more than a year or two. Another variable that may not be given the importance it deserves is the quality of earnings (GAAP vs non-GAPP earnings). Given the dozen or so valuation parameters that I review on a regular basis, I don't think the level of "real" (GAAP) earnings now or on a forward basis supports the continuation of the current bull market (that is now 6 years old). In fact, almost every recognized valuation measure is now at an extreme over-valued level.

So why are most major stock market averages at or near all-time highs?

1. The Federal Reserve has perpetuated a "zero interest rate policy" since the 4th quarter of 2008. While there have been rumblings of a potential Fed rate hike later this year (June or September), I don't think the latest batch of domestic economic numbers supports a rate hike just yet (and investors seem to draw strength from a "patient" Fed).

2. The level of corporate buybacks has been astounding in recent years, with no apparent end in sight. Corporate debt is now significantly higher than at its peak in 2008, and much of the new borrowing has been allocated to equity share buybacks (rather than the usual capital expenditures). This "borrow and buy" cycle is doomed, but the music hasn't stopped yet (even though there are clearly no more exit chairs).

3. Central banks on a global basis are actually buying stocks now. The Bank of Japan has already admitted to this extraordinary measure of monetary policy, but it is not hard to imagine that many other central banks are also quietly pursuing this "whatever it takes" policy in support of their respective economies.

In my view, the greatest worry for potential short sellers in the U.S. stock market is #3 above, central bank purchases of equities on a global basis. At one point, the shell game will end and the perceived omnipotence of central banks will be seriously questioned. Timing is everything, of course, and we simply don't know when that day will come.

I have always hoped that my computer trading system would let me know when the time is right for short sales in the U.S. stock market. And even though I have some interesting sell signals right now (housing sector stocks, see Toll Brothers chart below), except for the Russell 2000 weekly chart, I don't have any significant sell signals in any major U.S. stock indexes as of Friday's close. While patience has never been my strong suit, after more than 35 years experience watching and trading stocks, I feel the time is right now to begin shorting the indexes even though my computer system shows a dearth of sell signals. Yesterday April 24, I edged into 50% of my planned total short position (which also happens to represent 50% of my assets under management). I have no long positions, and the only long positions I would even consider right now would be mining stocks. Of course, I wish I had some VALE this past week (up 30%!). I think the Russell 2000 Index looks the most vulnerable here, but I've split my short sales evenly between the S&P 500 and the Russell 2000 (using SDS and TWM double-short ETF's, respectively).

Here are some interesting charts which tend to support my bearish view right now:

Dow Jones Industrial Average Weekly Chart with Computer-based Sell Signal 8 weeks ago

Nasdaq Composite Daily Chart with Friday's Price near the 3-standard deviation Upper Bollinger Band

Nasdaq Composite Monthly Chart with Friday's Price near the All-time Intra-day High In March 2000

Russell 2000 Index Weekly Chart with Computer-based Sell Signals 2 and 8 weeks ago

Toll Brothers (TOL) Monthly Chart with a Computer-generated Monthly Sell Signal at Friday's Close