Summer has finally arrived on the East Coast!
No joke—last week we had our first 5 day stretch without rain here since Memorial Day. The mushrooms growing under the Ark we constructed in the office parking lot are in danger of shriveling. Might this favorable stretch of weather have any implications for the direction of the capital markets the rest of the year? Before you think we have gone off the deep end and are beginning to employ astrological charts in our investment process (and you still might be right here), hear us out. Earlier this year we commented on the “sell in May and go away” myth. That quaint notion, borne of a simpler time before cell phones, laptops, wifi and DSL in the Hamptons, had its place in the white-shoe days of Wall Street, when market participants mutually made an unspoken, passive pact to do no harm during the summer months, when everyone’s attentions were focused elsewhere and communications with the office were slow and infrequent. The strength and volume associated with this current summer rally attests to the fact that the old gentlemen’s agreement regarding summer break is long dead. Still, with many of the near-term potential market catalysts such as quarterly earnings reports and significant monthly economic data now behind us and, most importantly, with congress on vacation (meaning fewer dangerous trial balloons) we may yet get our summer doldrums—they just may occur all in the month of August.
The market’s recent rally has many an “expert” calling for a pullback, retracement, profit-taking session or any number of other terms suggesting a reversal of the uptrend. We don’t disagree with the need for time to digest. Our anecdotal evidence is that a good deal of this rally can be attributed to short covering, in that many of the best performers are low quality, high short interest stocks trading under $5. We also note that retail investors are starting to belly up to the trough, judging from the volume and trade size in some of these higher flying issues, although the money market data and funds flow data have yet to bear this out. Both data points are classic causes for concern. Yet “digestion” doesn’t mean that stocks have to fall back to some technical preordained level to allow the rally to advance further. Treading water (now there’s a good old Wall Street technical term for you) sometimes works just as well to relieve the gas pains. True, the ownership profile of stocks may change in a sideways movement phase, but that isn’t necessarily bad. We disagree with the notion that retail investors being last to the party is a bad thing—especially if they help the “smart money” out of their positions during a flat spot in the market. All that would be happening there is that the cash horde changes hands from individuals to institutions—and we would strongly take the contrarian point of view as to which side is the “smart money”—and retail investors can be much stronger hands than institutional holders for any number of reasons. So, putting this thesis together with our August doldrum theory from above, we have good reason to believe in a small market sell-off at best and a boring (amen!) few weeks ahead of us.
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