Daily State Of The Markets: What Do The Cycles Say About April 2014?

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 |  Includes: DIA, IWM, QQQ, SPY
by: David Moenning

Stocks apparently broke out of what had been a fairly painful trading range on Tuesday as the S&P 500 pushed above both the old intraday and closing highs. Of course, the bears will argue that the move was unconvincing and that no other major index followed suit. To which, anybody adorned in a bulls cap will counter by pointing to the venerable DJIA as well as the Transports.

The reason for Tuesday's jaunt higher was that another one of the bullet points on the bear camp's list of worries was refuted.

Recall that on Monday, worries about the geopolitical issues in Russia/Ukraine as well as the concerns that Janet Yellen wouldn't continue to be Janet Yellen once she took over Ben Bernanke's seat at the head of the FOMC's table, were brushed aside. Just like that, two of the big stumbling blocks to higher stock prices had been removed.

Another One Bites the Dust

But the bears still had China. Well, until Wednesday that is.

As you are undoubtedly aware, China's economy, which is the world's second biggest, is slowing. The fear has been that in their quest to avoid a bubble bursting in the Chinese real estate markets, the powers that be might overshoot and slow the economy too much. And while 6 percent GDP growth would be considered gangbusters anywhere else in the world, most economist agree that a decline of that magnitude would be disastrous for the global economy.

The bear camp has argued that China's Central Bank is stuck between a rock and a hard place. If they moved to stimulate growth in the economy, it would cause the growing bubble in real estate to get out of hand. And if they pushed on the brakes too hard, debt defaults, which are beginning to occur for the very first time, could create a credit crisis.

So, when both China's Official and HSBC Manufacturing PMI's came in on the punk side again, the bears couldn't be blamed for thinking this was good news for their short positions. However, what our furry friends hadn't counted on was the idea that government officials would start talking again about stimulating the economy. And overnight Monday, that is exactly what transpired.

From a big-picture perspective, the bears had lost another argument. First Russia, then the Fed, and now China. And in response, stocks broke out to the upside. However, this seems to be a point of contention among traders.

Was That a Breakout?

The early point on this fine Wednesday morning is that a breakout is a breakout, until, of course, it is not. Take a look at the chart below. While many will argue this represents a textbook breakout, others may disagree.

S&P 500 Daily

So, anyone expecting to take a cue from Tuesday's action may be fooling themselves. Remember, the trick to this game is about staying in tune with what the market IS doing - not trying to predict what it will do next.

However... as we have discussed a time or two, the stock market does tend to move in cycles. Oftentimes, the market will inexplicably follow certain cycles like a little puppy dog wagging its tail. And therefore, it can be beneficial to know (a) whether or not this is one of those times when the market is in sync with the historical cycles and (b) what the cycle has to say about the coming month, quarter, and year.

So, since everyone in the game right now is basically waiting on either a clue as to whether Tuesday's action was a breakout or Friday's jobs report, we thought this would be a good time to take a peek at what the historical cycles say about what April may hold in store.

Time To Review The Cycle Projections

Since this is the umpteenth monthly review of the cycle composite, there is probably little need to go over all the disclosures/disclaimers again regarding the proper use of stock market cycle analysis. The bottom line is that the review of cycles should NOT be used in a vacuum or as a stand-alone indicator. Using only the cycle composite projection, or any other indicator for that matter, to guide your investing decisions is a fool's game.

With that said however, we continue to check out what the cycles suggest might happen on a daily, weekly, and monthly basis. In fact, this data continues to be an important input into our daily and weekly Market Environment models.

What Is a Cycle Composite?

For anyone new to our monthly analysis of the cycles (the closest thing we have to a crystal ball), the cycle composite is a combination of the one-year seasonal, the four-year Presidential, and the 10-year decennial cycles - all going back to 1928.

By combining these three cycles, a cycle composite is produced. And while expecting the market to follow the cycles exactly is just plain silly, it is surprising how often the market tends to follow the general direction of the composite - especially when viewed from a long-term perspective.

Question #1: Is The Market In Sync With The Cycle Projections?

The first step in the analysis of the cycles is to get a feel for whether or not the cycle projections are "on" or not at the present time.

Cycle Composite vs. S&P 500

Red line = S&P 500 Blue line = Cycle Projection

Looking at the above chart, which shows the market (the red line) relative to the cycle composite's projection (the blue line) we will have to answer the question with a resounding, "Yes!" as the stock market is almost exactly where the cycle composite expected it to be through the first three months of the year.

And from a longer-term perspective, the market (as defined by the S&P 500) continues to be largely in sync with the composite projection. For example, since 2010, the S&P is only a percent or so away from where it has been projected to be at this time.

Sure, the ride has been bumpy and there have been times that the market has diverged - sometimes rather dramatically - from the projected path. But four years and a multitude of crises later, it is incredible that the market is still in sync with its historical cycles.

What Does April Look Like?

The next step is to take a look at what the cycle projections are calling for during the coming month:

The S&P 500 Cycle Composite: The overall cycle composite suggests that April will be an up and down affair. As the blue line on the chart above indicates, the projection is for an early advance followed by a sharp pullback into the traditional "Sell in May and go away" period.

The NASDAQ's Cycle Composite: This year we're also looking at what the cycle composite has to say about the NASDAQ each month. The reason being that the projection for the year for tech-heavy NASDAQ Composite is very clear - a serious decline lies ahead.

Looking at April, the projection is a microcosm of the annual projection. In short, the NASDAQ is pretty much in line with the cycle composite so far and is projected to trace out a saw-tooth decline throughout the month. Perhaps this explains all the intraday selling we've seen of late.

In Sum

So to sum up, both the NASDAQ and the S&P 500 are now largely in line with the projection from the cycle composite. That's the good news. The bad news is that the cycles are calling for a late-April peak to be followed by a fairly meaningful and prolonged decline.

The takeaway here is that "Sell in May" may indeed be the battle cry this year. As such, this may be a good time to play your cards close to the vest and to book profits whenever you have them.

Publishing Note: I have an early meeting on Thursday and will not publish a morning report.

Turning to This Morning...

Continued talk of stimulus in China has buoyed markets for the most part overnight as traders await the next batch of jobs data due out over the next few days. Overnight markets were mostly higher with the exception of Italy and Spain. Futures in the U.S. are pointing to a flat-to slightly higher open at the present time.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:

- Japan: +1.04%

- Hong Kong: +0.34%

- Shanghai: +0.56%

- London: +0.26%

- Germany: +0.23%

- France: +0.10%

- Italy: -0.47%

- Spain: -0.37%

Crude Oil Futures: -$0.55 to $99.19

Gold: +$4.10 at $1284.10

Dollar: lower against the yen and pound, higher vs. euro

10-Year Bond Yield: Currently trading at 2.772%

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +0.18

- Dow Jones Industrial Average: +9

- NASDAQ Composite: +6.20

Thought For The Day... "Don't be afraid to take a big step if one is indicated. You can't cross a chasm in two small jumps." -David Lloyd George

Positions in stocks mentioned: none