You have heard the Wall Street aphorism “Sell in May and go away”. It is still too early, but so far the only things that have been sold in May are U.S. Treasuries and the Japanese Yen – assets that are currently on the other side of the “risk-on’ trade.
The consensus opinion has been that market averages are working on a rounding top. Last week, the market laughed in the face of the consensus opinion and broke out to new all-time highs. This time the rally was led by the right sectors – cyclical. Tops are a process, which could continue 3-4 months, they are always hard to identify in real time and there could be several sector rotations while they last.
The least treacherous way to understand financial markets is to comprehend the incentives of its major market participants. What would you do if you were an underperforming and underinvested manager coming into May? Do you stay on the sidelines and hope that the market will correct so you could buy the dip? Do you chase extended consumer staples, healthcare, and utilities? Or do you turn your attention to fresh breakouts in highly-liquid, high-beta stocks?
Some of the wisest words ever said about the stock market belong to Sir John Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” It is hard to define the current market stage as euphoria. There are still a lot of skeptics out there (skeptics = underinvested or short). Hedge funds are net short and dangerously underperforming again, which might spark a new chasing spree. Maybe this explains the sudden surge of interest in large cap tech stocks ($QQQ). Nasdaq 100 underperformed severely in the first four month of the year.
Momentum stocks outperformed by a wide margin for a second week in a row. The St50 index gained 3.42%. Only a few stocks lost ground, most notably $LNKD. LinkedIn absolutely crushed analyst estimates, but it was light on guidance – which was a good reason for many to take profits. The pullback is understandable. Expectations have been incredibly high, plus the stock had doubled in the six months before the last report. Its long-term trend is still intact, but let’s see at which moving averages buyers will step in again. A pullback to its rising 100dma or 200dma won’t be a surprise.
On the upside, there were 15 St50 stocks that gained 5% or more for the week and they belong to a wide variety of industries – restaurants ($RUTH), metal fabrication ($GTLS), 3D printing ($PRLB), $EXLP (oil & gas equipment)…
We don’t know if the latest breakout to new highs is a bull trap. Given the recent fakeouts, it is normal for many market participants to be cautious and watch with disbelief. This is exactly why the most surprising move that could happen in May is for the averages to climb higher. It doesn’t mean that it will surely happen, but we need to be open-minded to any scenario.
How do we know that the market is healthy? Stocks that went sideways for the past two months or so are finally breaking out and holding their gains. While the current market is meeting that requirement, it doesn’t mean that we should mindlessly chase already extended names. It makes a lot more sense to focus on fresh breakouts.
You can easily follow any or all of the stocks in the ST50 on StockTwits by clicking here.
Have A Great Weekend!