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Everyone Expects A Correction. So, What Do The Cycles Say?

Daily State of the Markets
Monday, April 8, 2013

Good Morning. Just about everyone in the game right now is anticipating a correction in the stock market. Most believe that it's not really a question of if the market will pull back from its recent all-time highs, but a matter of how bad the decline will be. The recent sideways divergent action in the indices, the faltering momentum, the defensive leadership, the bevy of punk economic data seen recently, the issues in Europe, the dive in interest rates, the action in metals, the crash in the yen, and even the latest outbreak of bird flu in China are cited as reasons that stocks can and should begin a precipitous decline any minute now.

Heck, I don't know of a single investor, trader, or money manager that expects stocks to move higher from here without pulling back first. And while I actually agree with the popular consensus that the bulls are due to take a rest right about now, I have also been around long enough to know that when everybody expects something to happen, it rarely does. Remember, Ms. Market has a funny way of doing whatever she can to frustrate the masses. So, if you are aggressively positioned for a pullback, you may want to recognize that your position is exceptionally crowded right now.

Yes, I am indeed concerned about the chart action on the NASDAQ, the Midcaps, and especially the Russell 2000 indices. The latter smallcap index is in a clear-cut downtrend at the present time, has busted through its 50-day moving average, and isn't that far away from putting in a "lower low." And from a chart-watcher's point of view, this would mean the intermediate-term uptrend, which has been in effect for more than four months now, would be toast.

However, as I noted last week, the charts of the S&P and the Dow are a horse of a different color. The S&P 500 is simply moving sideways at the moment, while the DJIA remains in a pretty impressive uptrend - and hasn't even broken its 10-day moving average (yet?). As such, followers of the blue-chip indices may wonder what all the fuss is about right now.

So, with the outcome of the game a bit of a question mark right now, I thought this would be an opportune time to check in with our cycle composite to see what history says "should" happen during the month of April.

As I've noted a time or two during such exercises, while the cycle composite is one of the inputs in our Market Environment Model, we would never consider making an investment decision based on the cycle work alone. You see when the cycles are "on," the market often follows the general trend of the cycle quite nicely. But, when the cycles are "off," well, they can be way off for a long period of time.

As you may recall, our cycle composite is comprised of the one-year seasonal cycle, the four-year Presidential cycle, and the 10-year decennial cycle. In looking at the cycle so far this year, the bottom line is that with the exception of the action seen in March, the stock market has been pretty much in tune with the cycle composite. As such, we will have to say that the cycles are currently "on" and that paying attention to what is projected to happen in April might be a worthwhile endeavor.

The good news is that unlike the projection for March, April's cycle composite trend is pretty straightforward. In short, the cycles suggest that April will be a strong month for stocks overall. In looking at the chart, the composite says things will be basically straight up until the last week of the month until some choppiness sets in. So, given that everyone everywhere is looking for stocks to fall, I personally find this interesting.

In looking at the components of the cycle composite, there isn't much variation on the theme to be seen. The one-year cycle suggests that the first half of the month will be strong and then stocks will pull back a bit going into May. The four-year cycle sports a downward trend in the first week, which is followed by a strong rally and then a pause near the end of the month. And then the ten-year cycle basically says "buy 'em!"

Looking at the cycle composite from a shorter-term perspective, the projection is positive each day for the next six days and eight of the next nine. But again, the general direction of the cycle projection is much more important than any daily reading.

My primary point on this fine Monday morning is that this is the type of environment where it is very easy to succumb to group-think. It is all too easy to assume that what the majority expects to happen will indeed happen. As I've mentioned, I too can rattle off a handful (or two) of reasons why stocks "should" decline from here. However, given that the cycles tell us that the month of April has been pretty darn good; this is also the time where it might pay to stop listening to the masses and make decisions based on what is actually happening in the market.

My view is pretty simple right now as my primary market models are neutral this morning. This tells me to follow the trend of the market (assuming one develops soon) and to try and be ready for the next big move. After all, the trick to making big money in the market over time is to consistently capitalize on the types of moves we saw from November through March and then try your darndest not to screw it up while waiting for the next big move. And for me, this means playing the game more conservatively until our models improve.

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Turning to This Morning...

It looks as if the flip-flopping back and forth between red days and green days may continue today as U.S. futures are following Europe higher in the early going. Despite some disconcerting headlines out of Europe, it appears that Japan's new easing efforts continue to be a tailwind. However, there is a fair amount of disagreement about what to expect from the earnings parade here in the U.S., which officially kicks off after the close today when Alcoa reports. Finally, the market internals remain sketchy at the present time so this is no time to become complacent.

Pre-Game Indicators

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

Major Foreign Markets:
- Shanghai: -0.60%
- Hong Kong: -0.04%
- Japan: +2.80%
- France: +0.56%
- Germany: +0.26%
- Italy: +0.25%
- Spain: +0.35%
- London: +0.34%

Crude Oil Futures: +$0.93 to $93.63

Gold: +$0.30 to $1576.20

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

10-Year Bond Yield: Currently trading at 1.722%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +4.37
- Dow Jones Industrial Average: +31
- NASDAQ Composite: +8.55

Thought For The Day...

"What the wise man does in the beginning the fool does in the end" -- Warren Buffett

Thought For The Day...

Every time you smile at someone, it is an action of love, a gift to that person, a beautiful thing. -Mother Teresa

Positions in stocks mentioned: none

Follow Me on Twitter: @StateDave

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