Russell 2000: Sell in May and go away?

Kevin Pendley | May 10, 2008 11:34am EDT | Comment

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You’ve no doubt heard the phrase “sell in May, and go away” in reference to sluggish price action accompanying recent stock market activity. The saying rhymes, it’s catchy and it’s fun to use. Heck, I’ve even bandied about the phrase myself in recent days when the market struggled.

In general, I’m a fan of market “truisms.” For the most part, such phrases became a part of market lore because they were rooted in some truth along the way. Ideally, I’d like to latch onto “sell in May, and go away” as a reliable catch phrase for trading action during the month of May forever. Many of us, after all, are reeling in May from the April tax bill, and we’re just not in the mood to scrape together new investment funds. What’s more, we might be socking away extra cash to pay for our upcoming summer vacation. It seems like Mother’s Day is about the only good reason to open our wallets during May.

With that in mind, I fully expected an analysis of May trading activity over the last 10 years to solidly back the “sell in May, and go away” premise. Alas, it just didn’t hold up to scrutiny. Over the last 10 Mays, small-cap stocks have been down just four times, and up on six occasions. The average decline on down years was 5.4%, and the average gain on rally years was 4.3%. If we exclude the meaty 10.6% rise back in 2003, then the velocity of the move on down years clearly is more powerful than the advance on up years, but 4 of 10 just isn’t good enough to rely on “sell in May, and go away” as a trading truism anymore.

Perhaps we could go back in time over the last 25, 50 or 75 years and find that the “sell in May, and go away” approach was statistically dominant. The problem is that things change, people change, markets change and I just don’t like to apply seasonal anomalies or historical price oddities to more than a 10-year time frame.

One thing that did catch my eye on the study...in 2000, the market was off 5.9% during May, and the long-term chart formation coming into 2008 had an enticing resemblance to the formations drawn back in 2000. Other than that, I think we’ll have to set aside “sell in May, and go away” as a cute saying that just hasn’t had much bang for the buck the last 10 years in small-cap trading patterns.

Now, focusing on the chart patterns that emerged this past week, the Russell 2000 (NYSE:IWM) once again stalled around the 731 zone. This area turned back the rally in early February and remains a potent resistance area now. The sellers who take a stand in that area continue to be rewarded, and the market will have to push through that line with conviction to spark another leg up for the move.

Daily charts look more top-heavy than weekly studies, with the dominant feature a bearish outside reversal on May 7 and a rejection of new move highs on May 2. We have now seen three outside sessions since just April 30, which is unusual. A sudden rush of alternating reversal patterns tends to reflect investor indecision and a potential shift in trend. With prices stalling at three-month highs, this is a risk zone for the market. If small caps do start to wobble and push through immediate support at 713.50, 708 and 700, then we’ll have to calculate Fibonacci retracement targets for the March-May rally. It would take a slide back below 681/672 to fully suggest that the recovery from the March trough was simply corrective in nature, and not bottom forming.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into this week’s trading. For long-term traders, some of these key levels may remain in place for weeks, even months at a time. Those with a short-term horizon will lean toward levels that are more immediately in play. As time passes, we will build upon this table with levels that come into focus as important testing zones for trend analysis, and to act as road mark indicators for key reversal patterns.

From a trading perspective, I always keep a printout handy each day of my key support and resistance points for any stock or market I’m trading. It helps remind me of key areas to watch for signs of trend exhaustion, and also for potential entry/exit points for trades.

TECHNICAL ANALYSIS SUPPORT/RESISTANCE POINTS FOR RUSSELL 2000

- 890.16   upward channel resistance on monthly charts off 5-year run;
            also fits with potential upside breakout of congestion zone
- 860.00   projected “figure” resistance off 15-handle testing zones on the ’06 rally
- 856.48   record intraday high set July 13
- 855.77   July 13 close; record high daily and weekly close
- 852.06   Oct. 11 high; bearish reversal peak on daily charts
- 830.01   previous high from the February 2007 peak; key swing line of note
- 815.00   key swing line
- 801.00   congestion resistance zone from November-December 2006
- 775.03   61.8% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
- 760.06   March correction low; key approximate double bottom formation support;
            Near 50% Fibonacci of July ’06-’07 bull run; violated in November ’07;
            Key swingline to watch
- 749.88   50% Fibonacci retracement of the Aug. 2007 record peak-Mar. 2008 collapse
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 734.40   previous key slide low; now resistance on a bounce
- 731.24   recent double top in Feb ’08; tested May 2
- 724.72   38.2% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse;
            violated late April 2008, but still worth watching
> 720.05   May 9 close
- 715.76   20-day moving average
- 700.00   “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 699.92   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 685.00   20% decline off 2007 record highs; breached Jan. 2008
- 680.94   mild reversal low on daily charts Jan. 28; near 50% of the March ’08 bounce
- 668.58   July 2006 low; important bottom for summer correction
- 660.00   short-term downside target on wedge breakout; support zone
- 650.00   previous bear market move low set Jan. 22, 2008, critical support zone
- 643.35   recent move low set Mar. 10, 2008
- 614.76   October 2005 bottom; next major chart related downside point
- 591.00   50% Fibonacci retracement of the 2002-2007 bull market run

In addition to the printout of support and resistance points to watch, I also like to keep in mind where sudden volatility can spring into the trading mix from the typical release of economic data and Federal Reserve activity.

After a relatively quiet week on the economic data front, things kick into high gear again this week, with a slew of important reports on the horizon. The likely highlights will be Tuesday morning’s Retail Sales release, and CPI on Wednesday. Take note that Federal Reserve officials are hitting the speaking circuit in force this week. In fact, there are several appearances that I left off the calendar, just to try and hit the highlights without going into information overload. Suffice to say that by the end of the week the market will likely have a better picture of where some of the key monetary policy officials see the economy headed.

The table below highlights calendar event risk for this week, with the emphasis on various economic reports. Our table below has a special “Risk Factor” designation, which is simply my assignment of risk to that event, ranging from 0 to 5, with 5 marking the highest risk for volatile market swings.

CALENDAR EVENT RISK ASSESSMENT

Risk
Factor Report/Item (all times Eastern)

2       Fed’s Evans speaks on the economic outlook (Mon., 9:15 a.m.)
0       Treasury Budget (Mon., 2:00 p.m.)
2       Fed’s Bernanke on “liquidity measures” (Tues., 8:20 a.m.)
4       Retail Sales (Tues., 8:30 a.m.)
0       Import Prices (Tues., 8:30 a.m.)
2       Business Inventories (Tues., 10:00 a.m.)
1       Fed’s Yellen “economic prospects” (Tues., 1:00 p.m.)
2       Fed’s Hoenig on the economic outlook (Tues., 1:00 p.m.)
2       Fed’s Fisher on the economy (Tues., 1:30 p.m.)
4       CPI (Wed., 8:30 a.m.)
2       NY Manufacturing Survey (Thurs., 8:30 a.m.)
2       Weekly Claims (Thurs., 8:30 a.m.)
3       Industrial Production (Thurs., 9:15 a.m.)
2       Fed’s Bernanke on “risk management” (Thurs., 9:30 a.m.)
2       Philly Fed Survey (Thurs., 10:00 a.m.)
2       Housing Starts (Fri., 8:30 a.m.)
2       Michigan Sentiment (Fri., 10:00 a.m.)