Where to go if you sell in May and go away

By Polya Lesova, MarketWatch

NEW YORK (MarketWatch) After a blowout first quarter, investors may be feeling a sense of deja vu both 2010 and 2011 saw an early rally in the stock market that was followed by a dramatic downturn beginning in the spring. As the markets historically worst six months of the year draw closer, many on Wall Street see another stock slide looming.

I do believe that weve set ourselves up for another seasonal downturn, said Jeffrey Hirsch, editor-in-chief of Stock Traders Almanac. May through October is typically the worst six-month stretch for stocks. Without the over-arching influence of the financial crisis, seasonal patterns are back in play, according Hirsch. Were getting defensive and cautious, he said. There are really no sectors that begin a bullish move right here. The rally so far has certainly been impressive. The S&P 500 index (SNC:SPX) gained 12% from January through March, posting its best first quarter since 1998. The Dow Jones Industrial Average (DJI:DJIA) rose 8% in the first quarter; among its components, Bank of America Corp. (NYSE:BAC) surged 72%, J.P. Morgan Chase & Co. (NYSE:JPM) gained 38% and Microsoft Corp. (NASDAQ:MSFT) rose 24%.

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Global markets fearing end of stimulus

Spain found itself in the market's crosshairs as mounting concerns over the economy sparked a sharp slide in the country's bonds, erasing the effect of the ECB's cash injection.

Sameer Samana, international investment strategist at Wells Fargo Advisors, wrote in a recent report that investors should take profits since the easy money has probably been made and the bulk of the rally is over. We believe the market is overbought and this years advance is very similar to last years, Samana said. Equities had also started 2011 on a strong note, but a series of shocks triggered a selloff in May that lasted for months. They included the end of the Federal Reserves second round of quantitative easing, high oil prices, the euro-zone debt crisis and the U.S. credit rating downgrade. Spooked, investors sold stocks, with the S&P 500 losing nearly 20% from a high in May to a low in October. This year, many of the issues that preoccupied investors in 2011 are still in play. The end of the Feds Operation Twist program in June is approaching. Oil prices are rising and could spike further if the West undertakes a military strike against Iran. Liquidity operations by the European Central Bank and the agreement on a second bailout for Greece have eased tensions, but Spains severe recession and rising bond yields are a reminder that the euro crisis is far from decisively resolved. Moreover, the pace of economic expansion in China, one of the worlds most important growth engines, is slowing down. Other risks are potential disappointment in U.S. economic data and corporate earnings. And all this comes as the U.S. presidential election looms in November.

So, with many strategists expecting some type of market pullback, what should investors do to prepare? Beware cyclicals, financials Id say be wary of the consumer cyclicals and focus on defensive sectors [such as healthcare and staples], and companies with strong balance sheets, earnings visibility and dividend growth, said David Rosenberg, chief economist and strategist at investment firm Gluskin Sheff. You want to be very selective within the financials, he said. Housing stocks have already priced in a housing recovery. In the financial sector, Rosenbergs firm has holdings in some Canadian banks Royal Bank of Canada (TOR:CA:RY) , Bank of Nova Scotia (TOR:CA:BNS) and Toronto-Dominion Bank (TOR:CA:TD) and in First National Financial Corp. (TOR:CA:FN) , a Canadian mortgage originator, while in the U.S. it owns shares in J.P. Morgan (NYSE:JPM) and Capital One Financial Corp. (NYSE:COF) . Financials are among the best performing sectors on the S&P 500 this year, along with information technology and consumer discretionary. The Technology Select Sector SPDR Fund (NAR:XLK) which offers broad exposure to the tech sector has gained around 18% this year, while the Financial Select Sector SPDR (NAR:XLF) is up nearly 20% in the same period. Among defensive sectors, the Health Care Select Sector SPDR Fund (NAR:XLV) and Consumer Staples Select Sector SPDR Fund (NAR:XLP) are up 8% and almost 5% year-to-date, respectively. Back to treasurys? Hirsch of Stock Traders Almanac noted that potential strategies include gaining exposure to U.S. government bonds typically seen as a safe haven, as well as short-selling stocks via exchange-traded funds. What we do on the defensive side is pick up some bond positions and some shorts, Hirsch said. He pointed to long-term Treasury ETFs, such as iShares Barclays 7-10 Year Treasury Bond Fund (NAR:IEF) and iShares Barclays 20+ Year Treasury Bond Fund (NAR:TLT) .

As for the AdvisorShares Active Bear ETF (NAR:HDGE) , which seeks to make money by short-selling stocks, Hirsch said: Were not in that yet, but were looking for a point to get in. Im not convinced that weve seen the top of this rally here. It definitely looks like the market is beginning to crack, but we may get one more push. Some strategists such as LPL Financials Jeffrey Kleintop think that even if there is a decline in the stock market, it may be less steep than in the previous two years due to some mitigating factors. First, central banks are now cutting rather than hiking rates, which should help to temper global recession fears evident during the past two years spring slides, Kleintop wrote in a research report. Second, housing is showing signs of improvement. Also, oil prices are up, but food prices are down, which may partially explain the rise in consumer sentiment. And Keith Wade, chief economist at asset management firm Schroders, pointed out that in contrast to 2011, macroeconomic expectations are lower this year, with economists looking for 2.6% global growth (compared to a consensus forecast of 3.6% growth around this time last year). Hugh Johnson, chairman of Hugh Johnson Advisors, believes meaningful risks face investors and various catalysts could set off a stock slide. My hope is that the stock market will correct 6%, not 20%, and that 2013 will be a good year, but I do think that the bullishness of investors will be tested much the way it was severely tested last year, he said.

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