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Where The Stock Market Goes Next In 2013

|Includes:DIA, QLD, PowerShares QQQ Trust ETF (QQQ), SMH, SPY

Before I delve into what my indicators show, let's review my expectations for 2013, which I published in my forecast issue late last year. Chart 1 shows the long term view of the Dow Jones Industrial average. The first series of red lines is what I expected to unfold in 2013 were Congress to fail to come up with a deal for the fiscal cliff. The dotted green line (to be followed by the second series of dotted red lines) is what I expected to unfold in 2013 if Congress succeeded in convincing the markets that a political war over the fiscal cliff would be avoided, allowing traders and investors to get back to making money in the stock market. I basically expected the Dow Industrials to rally to test the uptrend line drawn from the 2000 and 2007 peaks, near the 16,000 level. As the first quarter closes, the Dow currently sits approximately half-way from my expected goal (highlighted by the solid green line.) There is a similar trend-line running along prior peaks for the S&P500 near the 1600 level, which is very close to current levels. My expectation for the second quarter of this year is that second series of red dotted lines will commence either near the S&P500 1600 level (here,) or near the Dow 16,000 level if the rally can extend from here going forward. Remember, I trade my indicators, not any opinion I may have.

The second chart shows monthly progress of the NASDAQ index, with the blue bull/bear cycle line shown at the bottom of the chart since 2000. The history of this indicator shows four distinct phases of stock market movements as stocks rise in bull markets and fall in bear markets, which is what this game-changing indicator aims to track and predict. New bull markets (green low risk phases) follow bear markets (magenta extreme risk,) with sideways churn (yellow moderate risk) periods follow low risk phases, and either turns into a new bull phase, or a high risk blow-off bull one. The direction of the blue line, as well as the blue line crossing the black extreme high and extreme low lines, triggers a change from one phase to the next. We are currently in a high-risk blow-off bull phase (orange,) to be followed by a major bear market (magenta extreme risk,) once the bears score a big win on a corrective attempt going forward. The red projection line - based on monthly average return for each phase of the cycle (discussed further as we go over chart 3 below) - shows we face a peak next month that marks the high for the year, with odds incredibly high that the big bear win to start the next great bear will land during one of the corrective attempts following a peak next month.

The third chart shows the average monthly return for each phase of the bull/bear cycle, with the black line representing 2013 expected to track close to the orange line representing high risk blow-off bull phases, which it does. That orange line calls for a peak next month, followed by a series of corrective swoons. While that line may not look scary to the bulls, the peak next month marks the peak for the year, and the magenta extreme risk line can start at any time, depending on whether the bears can deliver a big win during those corrective attempts. Just because the bears failed in 2011 and 2012 to land that big win, such failures in 2013 are far from guaranteed. 1998 and 1999 were other high risk years where the bulls kept the bears away, and 2000 soon followed. 2006 and 2007 were other high risk years where the bulls kept the bears away, and 2008 followed. Need I say more?

The final chart is the weekly view comparison of high risk years. The point of this chart is to track the indicators at the top and bottom of the chart with what usually transpires during each phase of the bull/bear cycle. In this case, the current NASDAQ is compared with other high risk blow-off years of 1987 and 2007, though analysis is based on all prior high risk phases. The red and green circles show how the indicators cluster in specific portions of the chart, and offer a template of expectations for future movements of the indicators tracking current trading action. Since we trade off of these indicators, such information is extremely useful to us. This chart comparison also will show any deviation from expectations, which too is vital to know.

The prime question now is which of the rally phases are we currently in, the middle or final? The contrarian indicator at the top of the chart says either could be in play, with the former suggesting we have a month or so of rally still to go, while the latter says the top is landing very soon.

We will know for sure once the white contrarian line leaves those red circles - signaling the current rally phase has ended - and we get to see whether the ADX line is rising or falling by the time the white contrarian lines reach oversold levels.

If the ADX is trending south by the time the stock market becomes oversold on the next sell wave then we are likely in the middle rally position, and we would look to buy at that time expecting one final breakout run to unfold going into the summer to mark the final rally.

If the ADX line is trending north by the time the stock market becomes oversold the final rally is likely already complete, and we would look to hold short positions expecting the white dotted of the trend indicator line (for short trades once trends turn negative) to race into the yellow circle that represents the big win for the bears that signals the bull market is over, and next Great Bear phase begun.

So right now my strategies have me continuing to try to make financial hay on the long side while the investment sun is shining, though looking to aggressively move to cash in the non-too-distant future, especially if the Qs and SMH fail to join the breakout fun going forward, with the latter needed to force the bears into capitulating and reversing their positions to provide the fuel for the next up-leg of the rally. Hard to imagine stocks going much higher without the Qs and SMH breaking out, since they are so close to doing so.

Have a great weekend!


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Disclosure: I am long QLD, SMH.