The good news is:
• The secondaries have held up well during this decline.
Three possible scenarios
Least likely - the bull market continues.
In the face of declining markets for everything it is unlikely the Fed will attenuate the free money policy that has fueled this rally any time soon.
A final top usually occurs with deteriorating breadth indicators and weakening secondaries. That was not the case at the April highs.
The chart below covers the past 6 months showing the NASDAQ composite (OTC) in blue and an advance - decline line (ADL) calculated from NASDAQ data. ADL's are a running total of declining issues subtracted from advancing issues. Dashed vertical lines have been drawn on the 1st trading day of each month.
The OTC ADL confirmed the April index high and, relatively, has not fallen as much as the index.
New next chart is similar to the one above except it covers the past 10 years to show the strong negative bias of this indicator. Dashed vertical lines have been drawn on the 1st trading day of each year.
You can see the 2007 top was clearly unconfirmed. It would be unusual for a final top to occur with an OTC ADL confirmation like we had in April.
The secondaries usually underperform the blue chips ahead of a cycle top and that has not happened.
The chart below covers the past 9 months showing the Russell 2000 (R2K) in red and the S&P 500 (SPX) in green. Accutrack, a Fasttrack (http://fasttrack.net/) relative strength indicator is shown as a histogram in yellow.
Accutrack is still above the neutral line indicating the unusual strength of the secondaries. A condition rarely seen at cycle tops.
The chart below is similar to the one above except it covers the past 2 years to give you a longer term perspective on how this indicator has worked.
New highs confirmed the April high. Usually cycle tops are made with diminishing new highs.
The chart below covers the past 9 months showing the OTC in blue and a 10% trend (19 day EMA) of NASDAQ new highs (OTC NH) in green.
The chart shows the April highs confirmed by OTC NH.
The chart below is similar to the one above except is shows the 2007 top. OTC NH peaked in July and failed to confirm the late October index high.
Solid confirmations of the April highs and continuing relative strength in the secondaries suggest the rally will continue.
More probable - a rally for the next 2 weeks fails to reach new highs and the decline continues.
From a seasonal perspective the market can be thought of as similar to a football game. Once in a while a game runs into overtime, but, usually when the clock runs out the game is over. Typically time runs out in late April of the 2nd year of the Presidential Cycle.
The charts below show an average of the daily percentage change during the 2nd year of the Presidential Cycle.
The first chart shows the Dow Jones Industrial Average (DJIA) during the 2nd year of the Presidential Cycle since 1885 (125 years). On average the DJIA has peaked in late April and bottomed at the end of September. There has been a sharp rally during the last few days of May into early June.
The next chart is not quite as deep as the previous one. It shows the SPX averages during the 2nd year of the Presidential Cycle since 1928 (82 years).
The pattern is similar to the DJIA chart above.
The next chart shows the OTC during the 2nd year of the Presidential Cycle with data from 1963 (47 years). The bottom has arrived about a week later than shown in the longer term charts above.
The next chart shows the R2K during the 2nd year of the Presidential Cycle since 1979 (31 years). The pattern is similar to the OTC chart above.
There have been exceptions, but, on average late April through late September has been worst 5 month period of the 4 year Presidential Cycle. Also, on average there have been strong rallies at the end of May and end of June.
Since an early bottom in 2006 the market has not been following the average seasonal pattern very closely, however, so far this year the market has done a pretty good job of following the script for the 2nd year of the Presidential Cycle.
Most likely - The blue chips rally to new highs by the end of the 1st week in June, then the market collapses.
This may be wishful thinking.
The arguments from my least likely scenario apply. The April highs were confirmed by everything that matters so a retest of those highs should be expected. Those retests usually occur within 6 weeks so an early June top would be right on schedule. The market is extremely oversold so a sharp rally is not out of the question (10.6% for the SPX in 9 trading days). A rally that strong would convince most the bull market was still intact.
To distinguish this scenario from my least likely scenario breadth indicators such as the OTC ADL would fail to confirm the high, new highs would have to be considerably less than they were at the April high and the R2K would have to come up short of a new high.
Seasonality
Next week includes the last 5 trading days of May during the 2nd year of the Presidential Cycle.
The tables below show the return on a percentage basis for the last 5 trading days of May during the 2nd year of the Presidential Cycle. OTC data covers the period from 1963 - 2009 and S&P 500 data from 1928 - 2009. There are summaries for both the 2nd year of the Presidential Cycle and all years combined.
Average returns have been modestly positive by all measures over the coming week.
Last 5 days of May.
The number following the year represents its position in the presidential cycle.
The number following the daily return represents the day of the week;
1 = Monday, 2 = Tuesday etc.
| OTC Presidential Year 2 | ||||||
| Day5 | Day4 | Day3 | Day2 | Day1 | Totals | |
| 1966-2 | 0.62% 2 | 1.04% 3 | 0.96% 4 | 0.80% 5 | 0.76% 2 | 4.17% |
| 1970-2 | -1.40% 1 | -2.28% 2 | -0.90% 3 | 5.00% 4 | 2.09% 5 | 2.51% |
| 1974-2 | 1.12% 5 | -0.48% 2 | -1.58% 3 | 0.39% 4 | 0.14% 5 | -0.41% |
| 1978-2 | -0.97% 3 | 0.02% 4 | 0.03% 5 | 0.12% 2 | 0.20% 3 | -0.60% |
| 1982-2 | -0.38% 1 | -0.32% 2 | -1.29% 3 | -0.23% 4 | 0.10% 5 | -2.13% |
| 1986-2 | 0.59% 5 | 0.76% 2 | 0.57% 3 | 0.20% 4 | 0.55% 5 | 2.68% |
| Avg | -0.21% | -0.46% | -0.63% | 1.10% | 0.61% | 0.41% |
| 1990-2 | 0.31% 4 | -1.00% 5 | 0.84% 2 | 0.28% 3 | 0.04% 4 | 0.47% |
| 1994-2 | 0.90% 2 | 0.18% 3 | -0.16% 4 | 0.21% 5 | 0.28% 2 | 1.41% |
| 1998-2 | -0.88% 5 | -1.49% 2 | 0.18% 3 | 0.75% 4 | -0.87% 5 | -2.32% |
| 2002-2 | -2.13% 5 | -0.56% 2 | -1.68% 3 | 0.46% 4 | -0.99% 5 | -4.90% |
| 2006-2 | 0.48% 3 | 1.34% 4 | 0.55% 5 | -2.06% 2 | 0.65% 3 | 0.96% |
| Avg | -0.26% | -0.31% | -0.05% | -0.07% | -0.18% | -0.88% |
| OTC summary for Presidential Year 2 1966 - 2006 | ||||||
| Averages | -0.16% | -0.25% | -0.22% | 0.54% | 0.27% | 0.17% |
| % Winners | 55% | 45% | 55% | 82% | 82% | 55% |
| MDD 5/31/2002 4.82% -- 5/27/1970 4.52% -- 5/26/1998 2.36% | ||||||
| OTC summary for all years 1963 - 2009 | ||||||
| Averages | 0.11% | 0.07% | 0.03% | 0.19% | 0.29% | 0.69% |
| % Winners | 57% | 53% | 62% | 57% | 72% | 60% |
| MDD 5/30/2001 8.65% -- 5/25/1999 5.52% -- 5/31/2002 4.82% | ||||||
| SPX Year 2 | ||||||
| Day5 | Day4 | Day3 | Day2 | Day1 | Totals | |
| 1930-2 | 0.67% 6 | 0.17% 1 | 0.04% 2 | 0.58% 3 | 0.45% 4 | 1.90% |
| 1934-2 | 1.15% 5 | 0.52% 6 | 0.82% 1 | -0.41% 2 | -1.84% 4 | 0.24% |
| 1938-2 | -1.75% 3 | -2.62% 4 | -0.11% 5 | 1.29% 6 | -1.38% 2 | -4.57% |
| 1942-2 | -0.25% 1 | 0.25% 2 | 2.00% 3 | 0.25% 4 | -0.37% 5 | 1.88% |
| 1946-2 | 0.00% 5 | 0.75% 1 | 1.48% 2 | 0.26% 3 | -0.36% 5 | 2.12% |
| Avg | -0.04% | -0.19% | 0.85% | 0.39% | -0.70% | 0.31% |
| 1950-2 | 0.00% 4 | -0.11% 5 | -0.11% 6 | 0.38% 1 | 0.32% 3 | 0.48% |
| 1954-2 | 0.03% 1 | -0.24% 2 | 0.83% 3 | -0.41% 4 | 0.48% 5 | 0.69% |
| 1958-2 | 0.21% 5 | -0.05% 1 | -0.14% 2 | 0.14% 3 | 0.55% 4 | 0.71% |
| 1962-2 | -0.80% 4 | -1.90% 5 | -6.68% 1 | 4.65% 2 | 2.67% 4 | -2.06% |
| 1966-2 | 0.66% 2 | 0.35% 3 | 0.00% 4 | 0.30% 5 | -1.37% 2 | -0.07% |
| Avg | 0.02% | -0.39% | -1.22% | 1.01% | 0.53% | -0.05% |
| 1970-2 | -2.77% 1 | -1.37% 2 | 5.02% 3 | 2.53% 4 | 2.60% 5 | 6.02% |
| 1974-2 | 1.48% 5 | -0.24% 2 | -1.67% 3 | 0.62% 4 | -0.17% 5 | 0.02% |
| 1978-2 | -0.99% 3 | -0.29% 4 | -0.23% 5 | 0.29% 2 | 0.44% 3 | -0.77% |
| 1982-2 | -0.09% 1 | -0.34% 2 | -1.13% 3 | -0.40% 4 | -0.69% 5 | -2.64% |
| 1986-2 | 0.51% 5 | 1.41% 2 | 0.77% 3 | 0.55% 4 | -0.25% 5 | 2.98% |
| Avg | -0.37% | -0.16% | 0.55% | 0.72% | 0.39% | 1.12% |
| 1990-2 | -0.24% 4 | -1.07% 5 | 1.71% 2 | 0.06% 3 | 0.10% 4 | 0.56% |
| 1994-2 | 0.36% 2 | 0.34% 3 | 0.16% 4 | 0.06% 5 | -0.18% 2 | 0.73% |
| 1998-2 | -0.37% 5 | -1.49% 2 | -0.16% 3 | 0.49% 4 | -0.62% 5 | -2.14% |
| 2002-2 | -1.21% 5 | -0.86% 2 | -0.64% 3 | -0.28% 4 | 0.23% 5 | -2.75% |
| 2006-2 | 0.16% 3 | 1.14% 4 | 0.57% 5 | -1.59% 2 | 0.81% 3 | 1.09% |
| Avg | -0.26% | -0.39% | 0.33% | -0.25% | 0.07% | -0.50% |
| SPX summary for Presidential Year 2 1930 - 2006 | ||||||
| Averages | -0.16% | -0.28% | 0.13% | 0.47% | 0.07% | 0.22% |
| % Winners | 45% | 40% | 50% | 75% | 50% | 65% |
| MDD 5/28/1962 9.18% -- 5/31/1938 4.53% -- 5/26/1970 4.10% | ||||||
| SPX summary for all years 1928 - 2009 | ||||||
| Averages | -0.10% | 0.09% | -0.06% | 0.20% | 0.06% | 0.19% |
| % Winners | 52% | 56% | 49% | 60% | 59% | 61% |
| MDD 5/31/1932 14.20% -- 5/28/1962 9.18% -- 5/29/1931 5.92% | ||||||
Conclusion
The market is deeply oversold and due for a bounce.
I expect the major averages to be higher on Friday May 28 than they were on Friday May 21.
Last weeks positive forecast was a miss. This report is free to anyone who wants it, so please tell your friends. They can sign up at: http://alphaim.net/signup.html.
Is the market rational? In his latest newsletter, Jerry Minton looks at the Efficient Market Hypothesis and some of its implications. You can read about it and sign up for a free subscription at Alpha's website: www.alphaim.net.
Thank you,
