S&P 500: 3 Reasons to Expect the May Blues … But Not Yet

Have you been infected yet by the media’s crash talk? Most major financial media outlets predict a correction or outright crash. There are reasons to be worried about the ‘May Blues’ (sell in May and go away), but there’s also reason not to worry, yet.

According to CNBC, Dr. Doom is worried about a crisis bigger than 2008, and so should you.

There truly are reasons to expect some weakness (aka the ‘May Blues’), but perhaps just not yet.

Why Look for May Blues

1. Seasonality: S&P 500 seasonality for midterm election years is bearish. Click here for S&P 500 seasonality chart.

2. The Nasdaq-100 may be carving out a head-and shoulders pattern.

3. Stock market breadth is deteriorating. A truly rising tide lifts all boats, this rally isn’t. Large caps are in, small caps are out.

The chart below plots the S&P 500 (SNP: ^GSPC) against the IWM:IWB ratio. The IWM ETF represents the small cap Russell 2000, the IWB ETF represents the large cap Russell 1000.

The IWM:IWB ratio shows small caps quickly erasing an 11-months performance advantage.

Although this is a reflection of fragmentation, it should be said that, historically, this disparity does not foreshadow major immediate weakness.

Why Look for May Blues … Later

Simply because the media is looking for a crash right now.

CNBC: “I’m worried about a crisis bigger than 2008: Dr Doom”
MarketWatch: “Risk of 20% correction highest until October”
Investors Business Daily: “Why investors expect to ‘sell in May and go away’”
CNBC: “Wells Fargo strategist presents scary chart”

Based on various cycles, technical indicators and seasonal patterns, the Profit Radar Report proposed a May high back in January when it published the 2014 Forecast.

This outlook continues to be valid, however, it has now become the crowded trade.

The market will likely find a way to shake out the weak and premature bears, and fool the herd (the May 4 Profit Radar Report outlined the most likely route of this head fake).

In terms of technicals, the S&P 500 (NYSEArca: SPY) remains above important support and still within a chopping zone, obviously designed to hurt impatient investors. As long as this support holds, it’s dangerous to go short.

Even the weak Russell 2000 remains above an important support cluster (yes, more important than the 200-day SMA).

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

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Will Small Caps Lead the Market to All-time Highs?

Market timers often watch small caps for clues about possible trend reversals, but thus far the Russell 2000 Small Cap Index is going strong. Here’s a closer look at seasonality and support/resistance levels for the Russell 2000.

It’s said that major market tops are often preceded by weakness in small cap stocks. This premise makes sense, as small cap stocks are most sensitive to the ebb and flow of liquidity. As a liquidity gauge, small cap indexes like the Russell 2000 could be the canary in the mine.

The truth is in the pudding. Does this theory hold up against the facts? The chart below plots the S&P 500 Index against the Russell 2000. I guess the key point is how you define a “major” market top.

Small cap weakness foreshadowed the 2007 top, but wasn’t obvious at the 2010, 2011, and 2012 highs (at least not on the weekly chart).

What about today? Small caps are going strong and the canary is chirping and frolicking.

The second chart provides a closer look at the Russell 2000 (corresponding ETF: iShares Russell 2000 ETF – IWM).

The Russell 2000 climbed back above the green trend line originating at the October 2011 low.

Recent prior peaks supply various resistance levels (red lines) and today’s decline drove prices below the green November 15 support line (an early warning signal), but starting in mid-December small caps tend to outperform large caps. January is one of the strongest months for small cap stocks.

Historical seasonal patterns suggest that more strength lies ahead for small caps. Technicals support this view. This may drive small caps to new all-time highs (less than 4% away), but I doubt it will be enough to push the Dow and S&P to all-time highs. A break below technical support at 836 (green trend line support) would warn that this year is different.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.