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“Sell in May and go away.”

June 22, 2006

The recent sell-off in the market and historical precedent suggest that the market could be in for some tough sledding between now and the fall. The market has an uncanny habit of making an important low every four years, often in October. According to veteran market strategist and technician Bob Farrell, seven of eleven four-year cycle lows since 1960 have come in October. The worst six months of the investment year have historically been May through October. Since 1950, the average price gain in the Dow Industrials over that six-month period has been 0.7%.

In contrast, the Dow’s average gain from the beginning of November until the end of the following April has been 7.9%, or more than ten times better. Also since 1950, of the 20 worst percentage decline months, eleven were in August, September, and October. Twelve of the 20 worst weeks over that same period were also in August, September, and October, with 7 of the 20 in October alone. The preceding data provide fairly strong evidentiary support for the old market maxim: “Sell in May and go away.”

The damage done to the market in May, coupled with inflation worries, political uncertainties surrounding the mid-term elections, the continuing morass in Iraq, and fears that—in his efforts to reestablish his inflation-fighting credentials— Fed Chairman Bernanke may tighten “too much,” has convinced some market commentators that a bear market has begun. Charlie Blood, chief market strategist at Brown Brothers Harriman, typifies this group. He is calling for a peak-to-trough decline in the market of about 15%. From the S&P 500’s recent peak of 1325.76 (5/5/06), that implies a decline to about 1127, from which point Blood projects a solid up year in 2007. Perhaps it’s just semantics, but we would call that scenario, should it occur, a severe correction, not a bear market. The classic definition of a bear market is a 20% or greater decline from a prior market peak. Anything less than 10% is normally classified as a correction. The 10% to 20% decline area is no-man’s land, between correction and bear. Regardless what you call it, should it occur, it obviously wouldn’t be much fun for equity owners.

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