The old adage really worked this time. Obviously, May is not plagued by international problems every year, so the reasons behind abandoning the markets in May transcend the current crisis. The months of May are tough for several reasons. Institutions do an annual review every year and position their portfolios for the upcoming year in January. After the dust settles from the first quarter, it’s time to make some adjustments and get ready for the summer doldrums. School lets out at the end of May. Families are planning for vacations. Business slows down as well. Summer items tend to have a smaller profit margin. Even the market’s turnover tends to slow during summer. Volume turns light and traders start heading out earlier on Friday afternoons. It’s just the way the world works. When you throw an overbought market in April on top of a growing financial crisis in May on top of this normal cyclical pattern, the problem becomes worse. In January, the game plan was to increase risk and ride the wave of an economic recovery, slow though it may have been. After an excellent first quarter capped a year-long market advance that put the S & P up over 80% from its low, a break was imminent.

May has lost 900 Dow points or 7.9%, its worst May performance since 1962 and its worst monthly performance in over a year. The correction was led by the debt crisis in Europe. This is a crisis that took more than a decade to build, and it isn’t going to get repaired any faster than a BP oil spill. The Greek problem is just the tip of the iceberg. The problems unfolded further on Friday as Fitch cut its rating on Spain’s debt. The Spanish government passed new austerity measures to cut its budget deficit, which resulted in a lowering of the projected growth rate for 2012 and 2013. The government now sees growth of 2.5% in 2012, down from 2.9% and 2.7% in 2013, down from 3.1%. That was enough for Fitch to cut Spain’s AAA rating down to AA+. However, the commentary that came along with the downgrade was far more upbeat. Fitch continues to see a strong sovereign credit profile, sound financial sector, and a responsible public finance program.  Spain’s director-general of the Treasury said the AA+ rating is still a “very strong recommendation”.

The market reaction in the latter half of Friday’s trading focused on the sudden weakness in the Euro and corresponding strength in the Dollar. They were all the usual suspects that were hurt by the Dollar’s strength. After all, it was a Friday afternoon. Traders were looking forward to a long 3-day weekend and didn’t want to worry about any long positions vulnerable to weekend disasters. Spain’s downgrade gave them the push to get out and go home flat. The short side might have felt a little more comfortable going home still short, so the averages faded right into the close. If anything, one could say that the market reaction was somewhat muted. This is a good sign. It’s not that investors have stopped being concerned by the events in Europe and their residual impact on the US economy, but that investors have discounted the fact that Europe’s woes are likely to continue for years, and that we need to be braced for bad news.

are positives out there, mostly focusing on the upcoming earnings season. Even if the US were to face a “second dip” in the economy, corporations have never been so well prepared. Consider the piles of cash, namely over a trillion in dollars and cash equivalents, held by corporations. There will certainly be negative impacts on companies that are heavily reliant on overseas sales or are extremely sensitive to commodities. This will be a tough quarter for multinationals, Energy, and Basic Material stocks. However, we’ve seen these areas of the market deeply hurt by the crisis overseas. The question is, how badly hurt? The recent data did show domestic sales slow in May, slightly more than anticipated. The consumer has been more resilient than one would have anticipated, given the lack of a recovery in jobs. This Friday, we will see the May Employment report, perhaps the biggest piece of economic data due out this week. Expectations are for 505,000 new jobs. However, most of these jobs are expected to be census and government worker related jobs. The private sector may have added about 180,000 jobs. Since manufacturing has been the one sector doing well, this week’s report on May manufacturing from the Institute of Supply Management may also carry some weight.

Technically, the market is entering into a basing process. After the S & P and Dow slightly undercut their February lows and bounced, it will take time to consolidate the recent losses. We need to hold the recent intraday low of 1040. This bounce only took us up to the 200-day moving average at 1104 before losing ground on Friday. This holiday-shortened week should be one of consolidation and basing. We could back off to fill that little “opening gap” at 1068 on the downside and confined by 1104 on the upside. If we can successfully hold in this range, we would consider it constructive. The market’s volatility subsided slightly, but we remain vulnerable to the action in the Euro and China. However, as we move closer to mid-June, earnings and the domestic economic performance will become more and more important. How second quarter earnings held up during this time of turmoil will be an important factor in how much we can extract from a summer rally.