Friday, 4 May 2007

Sell in May and Go Away?

Are the stock markets closing in on a top? Here are my three concerns:

1. The share mania currently occurring in China. The chart below is a three year chart of the Shanghai Stock Exchange:

It has been rising exponentially for a couple of years and looks very overbought. Due a very large correction. As shown in February, this could spill over into other markets.

2. The Yen and the Carry Trade.

The Yen is almost back to where it was in February when it came off quite sharply. The Economist this week says that the Carry Trade has been unwinding and that the current weakening of the Yen is a result of Japanese individual investors moving their money offshore in search of higher returns. I, personally, don't buy that. The size of the Carry Trade is just too large to be offset by individual investors in such a short period of time and why would it be having such an effect now? So, I see the potential for a double top/bottom (depending how you look at it) and a trend change in the short/intermediate term. The worry for those of us invested in non-Yen related things, as shown in February, is that if positions have to be closed quickly then the most liquid assets get sold off first to cover those positions - e.g. stocks, precious metals, bonds, commodities. So, we could see a sell off across the board.

3. The company profits bonanza may be coming to an end.

HSBC says forecasts for 2007 earnings per share for S&P500 companies have fallen from $95 to $93 since the middle of last year. This follows years of double digit growth. If investors expectations of future performance turn down then share valuations will look very stretched on a forward earnings basis.

In the UK, rising interest rates, rising bankruptcies and a vulnerable housing market could have the same effect.

This will take longer to play out than the first two issues but if investor sentiment changes it could get nasty.

Oh, and the Sunday papers say not to sell up this May as it could be a bumper summer. If that isn't a contrarian signal, I don't know what is.

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