“Sell in May and Go Away” came early this year. Do you think Yellen had something to do with that?

The extraordinary central bank policies of the last few years have been a “strong tonic” (to say the least!) for global stock markets with speculative markets outperforming “investment grade” ones as the rally persisted. Market Psychology increasingly became, “What, me worry?” as investors were taught to “Buy the Dip” and margin debt soared to all-time highs.

This “irrationally exuberant” condition lasted until about a month ago when the more speculative markets reversed… for instance, the Russell 2000 is down ~ 9% from its early March All Time Highs. The investment grade share indices slumped a bit in March but rallied back to make new all-time highs, by a whisker, on Friday April 4/14 following the employment report. But on that day they also turned lower, joining the more speculative markets in a broad based sell-off. At the April 11/14 close the DJIA was down 616 points (~4%) from its All Time Highs, all of the major American and European stock indices were red YTD, while the Toronto market was a notable exception up roughly 4% YTD.

Meanwhile  investment grade bonds have had a strong rally YTD.

Many markets have been driven to speculative excesses and are due for a correction. It feels to me as though the necessary “correction” has started and that the “Sell in May and Go Away” trade came early this year. The more speculative the markets, the more “overbought” they became and the more “breath-taking” their correction is likely to be.

The volatile “churning” we saw in the stock indices last week may be symptomatic of a reversal, a turn in the markets may have a single identifiable cause or the market may seem to roll over for no particular reason. In my view Market Psychology needs to get into a “Condition” where it is ripe for a correction and then the littlest thing can act as the catalyst for a reversal. In terms of any “little thing” I’m wondering if somewhere in the back of the Market’s Mind there is worrying thought that Yellen doesn’t like the “Inequality” that has been created by the huge, Fed induced, stock market rally… and that “dove or no dove” she may have her own reasons for tapering.

Where’s the Trade?

Last week, when commenting on the bizarre market condition that had taken Spanish 5 year bond yields below American 5 year Treasuries we asked, “Where’s the trade?”  Answering my our own question we acknowledged that we can’t pick the end of an extremely powerful trend (the rush of speculative money into hot markets) BUT… we said that if we were a portfolio manager we would reduce  exposure to stocks and increase exposure to investment grade bonds. In other words, get defensive. We maintain that view.

We also said that we liked the US Dollar and it fell against most currencies this past week on the idea that the Fed is not going to tighten as soon as previously thought. That presented us the opportunity to establish short call option positions in Euro, AUD and CAD.

Our caution about trying to pick a top in the stock market kept us from getting short stock indices. From an emotional point of view not making money from a short stock position was more painful than actually losing money on a trade! But as a dear old friend loves to say, “There’s a rumor going around that the markets will be open again next week” which means that the past is the past and there will be good trading opportunities in the future!