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Stock Market Cyclical Bull Faces Important Test

|Includes:DIA, QQQ, SPDR S&P 500 Trust ETF (SPY)

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Fueled by a historic amount of stimulus from the Federal Reserve, the cyclical bull market in stocks that began in 2009 has accelerated into an unsustainable advance, causing investment risk to increase to one of the three highest readings during the past 85 years.

Following the low in 2010, the stock market rally has exhibited the characteristics of a classic bubble as defined by a log periodic advance. The violent decline in January was a meaningful breakdown, signaling that the bubble may have begun the topping process. Since then, short-term market moves have become increasingly violent. When it occurs during the final phase of a highly irrational advance, this type of behavior is usually indicative of speculative exhaustion.

From a short-term perspective, the decline last week favors the development of another violent downtrend heading into the next meaningful short-term low. On April 4, our cycle analysis identified the formation of the latest alpha high (AH). Additionally, we noted that a quick move below the short-term cycle low (STCL) in late March would signal the likely transition to a bearish translation. Since the formation of the AH, stocks have moved well below the last STCL, confirming the transition to a bearish short-term translation and favoring additional weakness heading into the next STCL in late May.

Looking ahead, if an extended alpha phase decline is followed by a weak beta phase rally and an extended beta phase decline, the new bearish translation would be reconfirmed and additional short-term weakness would be forecast in June and July.

Alternatively, an extended beta phase rally that returns to recent long-term highs followed by a beta phase decline that holds well above the forthcoming beta low (NASDAQ:BL) would suggest that cycle translation is in question.

As always, these scenarios are approximations that represent the most likely possibilities identified by our computer models and actual price behavior will likely deviate from both. However, note that both scenarios suggest the current environment of extreme volatility is likely to continue for at least the next several weeks. From an intermediate-term perspective, the decline last week moved the S&P 500 index well below support at the lower boundary of the uptrend from 2011. Additional weakness next week would confirm this breakdown on the weekly chart and strongly favor the bearish short-term scenario that was outlined above.

As we often note, a cyclical top is a process, not an event. A confirmed breakdown on the weekly chart would be a significant technical signal, and market behavior during the next several weeks will determine if the next cyclical bear market is likely commencing.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: SPY, DIA, QQQ