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The cliche to "Sell in May and go away" seems to be borne out, again. Evidence is accumulating that the stock market has hit an intermediate-term peak amid the deepening European sovereign debt crisis, signs of slower U.S. economic growth and the imminent end to the Federal Reserve's liquidity injections.
All of which could have been written in May 2010. Deja vu all over again seems an equally apt cliche.
After the Standard & Poor's 500 broke below its 50-day moving average, nearby S&P futures were hovering a few points above the psychological 1300 level in early Wednesday trading in Asia. Bourses in the region also were in the red with the eagerly awaited Glencore initial public offering down more than 2% in early trading in Hong Kong.
While the S&P fell through its 50-day moving average, it remains far above its 200-day moving average, a sign the broad market is extended, according to John Mendelson, the esteemed veteran technical analyst now with Ed Hyman's International Strategy & Investment Group. Mendelson likens the stock market to a stretched rubber band in a presentation to ISI clients -- just as it was in April 2010 before the S&P retreated 16%.
Meanwhile, the market's leadership has narrowed while the major averages made marginal highs. The number of new highs has declined steadily while the market's erstwhile leaders -- Apple (AAPL), Freeport-McMoRan Copper & Gold (FCX) and Deere (DE) -- all topped out weeks ago. This is "classic stuff," Mendelson says, pointing to "serious negative divergences" in the stock market.
Another warning sign has been the poor relative strength of financial stocks, which has lagged the market for a while. While financials have long ago ceded the market's leadership, "you do expect them to be in the game," he adds.
Similarly, the Morgan Stanley Cyclical Index has been losing relative strength to the Morgan Stanley Consumer Index, showing the more defensive consumer names have been outperforming over the past three months.
But, as with the S&P 500, Mendelson also notes the Consumer Select Staples SPDR exchange-traded fund (XLP) also is far a above its 200-day moving average. Health-care stocks, which he tracks via the S&P Supercomposite Health Care Sector Index, also look "extended." These two defensive groups look ready to "come down and join the market on the downside," the ISI technician concludes.
Similarly, Woody Dorsey, who heads Market Semiotics in Castleton, Vt., says a corrective phase has been confirmed and is due to run into the July 1 zone. The divergence between the overall market making marginal highs and the deterioration in his sentiment indicators had become extreme, Dorsey wrote clients this week.
Short term, the "most negative zone is due from 6/1 into 6/22-7/1." After that, he sees a "strange, spasmodic recovery" in August "followed by a better break in the fall." That also would be in keeping with the typical seasonal patterns of steep drops in September and into October.
Among sectors, he also points to the recent retreat in the "darling" drug stocks, a big portion of the weakening health-care sector noted by Mendelson, as confirmation of a wider correction. Moreover, Dorsey also sees a steep break in retailers, which had held up surprising well, as further confirmation of the correction.
In addition, Dorsey sees the recovery in the "deeply oversold" dollar continuing in "fits and starts" into August. As Barrons.com's technical analyst, Michael Kahn, observed earlier this week , stocks and the dollar have had a nearly perfect inverse correlation.
Although the S&P 500 is down 3% since the end of April, that doesn't mean it's too late to sell in May and go away.
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