May 2010 Stock Market Commentary

The major averages tanked in May as European contagion woes spread, sending investors running for the hills. The 10-week rally which was confirmed on the March 1, 2010 follow-through day (FTD) and helped the major averages rally to new 2010 highs and new recovery highs, ended on May 5, 2010 when the major averages violated and closed below their respective 50-day moving average (DMA) lines. One day later (May 6th) will go down in history as the day of the “flash crash” which sent the Dow Jones Industrial Average plunging an unprecedented 1,000 points in 30 minutes. This type of violent sell-off illustrated how weak the market actually is and led many to question the health of our markets after an incredible 15-month bull move.

Bullish Case:
Since the March 2009 bottom, the benchmark S&P 500 has pulled back a handful of times, each mild, not exceeding -10%. As of this writing, the last trading day of May, the S&P 500 is down -10% from it’s April 26, 2010 high of 1,219. So far, this is “inline” with historical precedent and could be a temporary correction, albeit steep, before the bulls return and resume this powerful uptrend. This is a bullish sign for this new bull market, since every time the market has pulled back the bulls have promptly showed up, quelled the bearish pressure, and defended support. The question is whether the bulls will be able to do it again.

History shows us that most bull markets last between 18-36 months before they fail. Therefore, the fact that we are only beginning our 15th month bodes well for this somewhat “young” and bull market. Third, nearly every government across the globe stepped up and unanimously infused an unprecedented amount of capital into the global economy. This unified action saved the global economy from entering a deeper recession and laid the foundation for this robust rally. Fourth, most governments (i.e. central banks) are still keeping rates near historic lows to help spur economic growth. Fifth, it appears that the major averages managed to find support near their 2010 lows which could, in the short-term, be an important sign.

Bearish Case:
Sovereign debt woes continue to be the bane of this rally. At the end of April the S&P Rating Agency downgraded Greece’s debt to “junk” status, which accelerated the steep sell-off in the euro and sent it down to its 2008 lows! This sparked a world-wide panic sell-off which sent stocks plunging. In addition, Spain and Portugal’s debt was also downgraded which put pressure on a host of capital markets. Italy and Iceland are the two nations which analysts believe are also dealing with ominous debt levels. All of this helped the US dollar enjoy one of its strongest gains against the euro in over a year. Since November, the greenback has rallied smartly and jumped above its 50-day moving average (DMA) and 200 DMA lines. As expected, the stronger dollar sent US stocks and a slew of commodities (i.e. dollar denominated assets) lower as investors continue to debate our economic future. 

The fact that all of the major averages, and a handful of leading stocks, sliced below both their 50 and 200 DMA lines (on heavy volume) last month illustrates how weak this market actually is. The bears believe that the effects of the massive worldwide stimulus packages from 2008-2009 are beginning to wane and the future of the global economic recovery may not be as robust as initially expected. The bears also claim that technically this rally is done and overdue for a serious intermediate-term correction. Since the March ’09 lows, the major averages have retraced (rallied back) a little over +50% of their 2007-2009 bear market decline, which is a fairly typical bounce before a new down leg ensues. Only time will tell exactly how this plays out.

Market Action:  Price & Volume D
As we all should know, the major averages topped out in October 2007 and then proceeded to precipitously plunge until they put in a near-term bottom in early March 2009. Since then, the market snapped back and enjoyed hefty gains which helped send the major averages to one of their strongest 14-month rallies in history. The small cap Russell 2000 Index was the standout winner, surging a whopping +117%. The tech-heavy Nasdaq Composite is a close second, having vaulted +100%, before reaching its interim high of 2,535 on April 26, 2010. The benchmark S&P 500 Index raced +83% higher before hitting its near term high of 1,219 on April 26, 2010, and the Dow Jones Industrial Average soared +74% before printing its near-term high of 11,258 on April 26, 2010.  

This data indicates that Monday, April 26, 2010 appeared to be a very important day for the market because that is the day that most of the popular averages printed their near-term highs and negatively reversed by closing lower from new high territory. In addition, after such hefty moves, a 10-12% pullback, if holds, would be quite normal before the bulls return and send this market higher. Remember we are now waiting for a new follow-through day (FTD) to emerge before the window opens to proactively begin buying high quality breakouts meeting the investment system guidelines again. Trade accordingly. Never argue with the tape, and always keep your losses small.

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