Daily State Of The Markets: What Do The Cycles Say About 2013?

Includes: DIA, SPY
by: David Moenning

Good morning. While long-time readers know that I simply abhor the predictions game, it seems that one of the most popular things I write about each year has to do with the historical cycles of the stock market. In the past week, I have received a handful of notes asking me to update the report I did at the beginning of 2012, which laid out how the markets had acted historically from a one-year, four-year, and ten-year cycle perspective. So, given that the market appears to be waiting on the start of the earnings parade right now, I thought this would be a good time to look at what the cycles say about 2013.

But before we begin, let me be clear that I commit the vast majority of my time to identifying what "is" happening in the market (as opposed to what I think "ought" to be happening). As I've mentioned a time or twenty, Ms. Market doesn't give a hoot about what I think "should" be happening in her game or what "could" happen next. And it is for this reason that we do not allow the use of the words "should", "could", or "would" in our office when referencing the stock market action.

Let's also be clear about another thing: I am NOT suggesting that anyone should invest according to what the cycles say. No, I believe that the best way to succeed in the long run is to stick with your investing strategy/discipline and to follow your systems. Although markets can make any strategy look silly at times, I truly believe this is the key to long-term success in the business of investing.

With that said however, I have found over the years that cycle analysis can provide a very nice overview of what to expect. In short, this helps us to be on the lookout for important changes in the trend of the market, which can make implementing trades easier on the psyche on occasion. But, I will have to admit that the cycle projections can indeed be a great guide to what lies ahead at times. And then at other times the cycles are, well... utterly useless! But, before you click the delete button, it is important to note that when the cycle composite is "on" it tends to be dead on! And believe it or not, the cycles have been more "on" than "off" in recent years.

Finally, it is important to disclose that I can't lay claim to the cycle-composite concept. No, it was the fine folks at Ned Davis Research that originally put together a composite of the rolling one-, four- and ten-year market cycles and keep them updated each year. So, without further ado, let's get to it.

The Cycle Projections for 2013

The good news is that the cycle composite suggests that the bull market will continue in 2013. The bad news is that (a) the cycles do not line up as well this year as they have in the past and (b) there might be some fairly significant bumps along the road.

For example, the one-year cycle shows stocks advancing fairly steadily through the beginning of May, then stumbles for a bit. However the pullback is projected to be short and sweet, and by the beginning of June, the bulls are back in charge. This rally takes the indices to new highs for the year until the traditional fall correction shows up in early September. But, by the beginning of November the cycle says it will be time to get onboard the year-end rally that will wind up pushing the index to the high of the year.

However, the four-year (aka the Presidential cycle) and the ten-year cycles paint a picture that isn't quite as pretty - especially in the first quarter. In short, these two cycles suggest that a decent correction will begin in late-January/early-February before bottoming out (at a low for the year) in March.

In reviewing the cycle composite (the combination of the one-, four-, and ten-year cycles) it looks like the first half of January should be strong. However, from there until the beginning of March, it appears that stocks could first stagnate and then falter - falling into the red for the year in the process. Could this coincide with the expected budget battle? Only time will tell, of course, but it's definitely something to keep in mind.

But from there, the composite says things look pretty good. After a quick rally-pullback phase in March, the cycle is fairly straight up into July, where things then turn sideways until the usual sloppy period begins in September. What is surprising is that unlike most years, this particular composite set doesn't suggest a very strong year-end rally. Yes, things do pick up in November and December, but the composite index does not recover back to the highs set in July.

In sum, there are divergences in the cycles this year - almost immediately in February and then again in the fall. So, we'll need to keep an eye on how the market tracks these projections to see if either will be of any assistance as the year progresses.

As I stated above, the important thing to keep in mind when looking at this type of analysis is that when the cycles are "on" the market tends to eerily follow the pattern. But once things go off the tracks, it can be quite some time before the market gets back in line.

So, while all of the above needs to be taken with about a block of salt, I believe it is worth being aware of what "could" transpire in the coming year.

Finally, it should be noted that the cycle composite is one of the 10 inputs to our Market Environment Model employed by the Daily Decision Service.

Turning to this morning ... Things are fairly quiet in the pre-market despite a pullback in Asia and a plethora of economic data in Europe. European markets are modestly higher while U.S. futures are sagging at the present time. It would appear that traders are awaiting input from the earnings parade. (Monsanto reports before the bell and Alcoa officially kicks off the season after the close today).

Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell ...
Major Foreign Markets:
- Shanghai: -0.41%
- Hong Kong: -0.94%
- Japan: -0.86%
- France: +0.66%
- Germany: +0.12%
- Italy: +0.80%
- Spain: +0.71%
- London: +0.25%
Crude Oil Futures: +$0.36 to $93.55
Gold: +$7.00 to $1653.30
Dollar: higher against the yen, euro and pound
10-Year Bond Yield: Currently trading at 1.903%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -1.89
- Dow Jones Industrial Average: -18
- NASDAQ Composite: -3.22
Positions in stocks mentioned: none