Illusions, Fractals and Sell in May

Corrections of 5% or more have historically averaged about five times per year, and we have not had one since last November. I see ominous signs that the next significant correction started yesterday on April 1st and that hopes for a sustained advance and success of leading stocks - mostly based on artificial Fed support - is growing more illusionary than ever.

I avoid basing my analysis on the indexes for naïve manipulated tourists like the DJIA or even the SP-500, but prefer to focus on the risk-sensitive small caps index Russell 2000 and its ETF (IWM), and its correlation with price/volume movements as measured by the most reliable IBD’s Accumulation/Distribution ratings.

A sharp drop below the 20dma in the correlation score yesterday presented a striking fractal similarity with last year’s pattern of a head and shoulder top around the same date of early April. If the pattern is confirmed in the coming days, we are just down a choppy head formation with limited short term cash or shorting opportunities until the right shoulder forms right in time for the “Sell in May and go away” motto with the 9, 20, and 50 dma’s rolling over altogether. That’s when the best shorting opportunity should present itself, on the next retest of the IWM score’s 20 dma.

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The perfect chart symmetry is really striking, as much as the typical choppiness preceding a major top. On the next chart, in the lowest pane, note how the RS of IWM vs. SPY is already breaking down and well below its own 50 dma in red. Yesterday’s down thrust happened on the highest volume since January 1st, and looks like a reverse pocket pivot on the 50 dma RS line.

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Confirming the shift in market risk sentiment is the accelerating outperformance of defensive sectors (utilities, healthcare, consumer staples).

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Today April 2 is the last day with a positive seasonal bias before a streak of 6 consecutive days of very negative seasonal bias and it will be interesting to observe if the QE/POMO magic will be able to counter the natural downward tendency of the market in this time of year.
Billy

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