Daily State Of The Markets: The Cycles Say We Should...

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

Up until Friday morning at about 3:00 am Eastern Time, the U.S. stock market appeared poised to make a break for the border. More specifically, it looked like traders had put the worries about the earnings season, Greece, the economic data, and the Fed behind them. In fact, it looked like the historical cycle projections were about to play out - and that dear readers, would have been a good thing.

However, immediately following the announcement that Chinese officials had a) put new limits on margin trading and b) allowed for more short selling on the exchanges, traders decided it was time, once again, to go the other way.

Never mind that the S&P 500 was just 12 points from the Promised Land. Never mind that the venerable blue chip index had managed to trade above its 5-day moving average for 9 consecutive days. Nope, when Chinese officials basically announced that things were getting out of hand in their stock markets (the Shanghai Composite Index was up more than 14% in April alone and had more than doubled in the preceding 12 months) well, traders and their computers took the hint.

Just like that, stocks reversed course and markets around the world shed a percent or two in value. And don't look now, but it appears that the S&P 500 has now embarked on the 11th change of direction so far in 2015 - and the 13th since December 1st. The word you're looking for here is, choppy.

Where To From Here?

So, with traders once again fretting about anything and everything, the question of the day would appear to be: Where do we go from here?

While I do not believe in trying to predict what Ms. Market (or perhaps more accurately, the algos at the likes of Goldman Sachs, Citadel, and Virtu) is/are going to do next, I have on multiple occasions detailed the eerie accuracy of what we call the "cycle composite." So, we thought it would be a good idea to check in with the historical cycles for some guidance.

What Do The Cycles Say?

To refresh your memory, the "cycle composite" mashes together three historical cycles (the 1-year seasonal cycle, the 4-year Presidential cycle, and the 10-year Decennial cycle) to create a single composite forecast. And as long-time readers know, it is simply amazing how often this forecast is dead on.

Exhibit A is the chart below. The red dashed line represents the cycle composite's forecast going back to 2010 and the blue line represents the actual S&P 500.

What should immediately jump out at you is the fact that the composite has been pretty much spot on the vast majority of the time (it isn't always right, mind you!) - for more than 5 years now!

Take a look at the area I circled on this chart and note that the current market sits at almost the exact spot the cycle projection suggested it would. I would call that "scary good."

The Cycle Says 2015 Should Be Quite Strong!

The second big takeaway from the chart is what the forecast for the remainder of 2015 looks like. Can you say, "straight up?" (Well, with the exception of the usual pause during the summer doldrums, that is.)

So, since the cycle projections have been spot on for years now, investors can rest assured that once the current bout of algo-induced hysteria dies down, stocks could easily return to their natural course, right?

Well... According to some new research, maybe not.

Maybe, Maybe Not...

While I don't read many folks' opinions on the stock market (it is important to find those you trust and stick with them), I do like to peruse the work that Dana Lyons of J. Lyons Fund Management every so often. And a recent piece Dana did on the Presidential cycle caught my attention.

According to Mr. Lyons' research, the key to the traditional success of Year 3's of the Presidential cycle is the ability of the DJIA to make a new high for the calendar year during the month of April.

Cutting to the chase, if the Dow makes a new high for the year in April, the rest of the year is typically strong. And if not, well, not so much!

Source: Dana Lyons, J. Lyons Fund Management/My401kPro.com
Link to Dana Lyons Report

Here's the data Mr. Lyons developed on the situation.

Source: Dana Lyons, J. Lyons Fund Management/My401kPro.com
Link to Dana Lyons Report

What's the Takeaway?

So, looking at the cycle composite's forecast, we can conclude that the cycles favor the bulls here - in pretty stunning fashion. But with a hat-tip to Mr. Lyons, there may be a fly in the ointment if the Dow doesn't manage to make a new high for the year in the next two weeks.

Turning to This Morning...

On Friday, traders worried that officials were trying to put a damper on the furious stock market rally that has been occurring in China. However, a larger than expected cut in the RRR (Reserve Requirement Ratio), further efforts to help the agricultural sector, and talk of a new loan program akin to the ECB's LTRO, has the market singing a different song in the early going this morning. However, the PBoC went out of its way to downplay the significance of its moves, saying the 100 bp cut in RRR (the biggest since 2009) did not represent a shift in monetary policy and instead was an effort to "fine tune" its current plans. Worries across the pond are also receding this morning as the word default is no longer being used in every sentence referencing Greece. And finally, analysts are suggesting this morning that the earnings season here in the U.S. is not as bad as had been feared so far. As a result, U.S. stock futures, while off their best levels, currently point to a rebound on Wall Street.

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

Major Foreign Markets:
Japan: -0.10%
Hong Kong: -2.02%
Shanghai: -1.64%
London: +0.68%
Germany: +1.49%
France: +0.34%
Italy: +0.32%
Spain: -0.39%

Crude Oil Futures: -$0.59 to $55.15

Gold: -$4.00 at $1199.10

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

10-Year Bond Yield: Currently trading at 1.873%

Stock Indices in U.S. (relative to fair value):
S&P 500: +10.87
Dow Jones Industrial Average: +118
NASDAQ Composite: +19.20
Thought For The Day:
"What the wise man does in the beginning the fool does in the end" -- Warren Buffett
Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of Fed/ECB Policy
2. The State of the Earnings Season
3. The State of the U.S. Economy
4. The State of the U.S. Dollar
The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Neutral
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 2 years)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

  • Key Near-Term Support Zone(s) for S&P 500: 2040
  • Key Near-Term Resistance Zone(s): 2120

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

  • Trend and Breadth Confirmation Indicator (Short-Term): Neutral
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator: Neutral
  • Breadth Thrust Indicator: Neutral
  • Bull/Bear Volume Relationship: Neutral
  • Technical Health of 100+ Industry Groups: Moderately Positive

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • S&P 500 Overbought/Oversold Conditions:
    - Short-Term: Moderately Overbought
    - Intermediate-Term: Neutral
  • Market Sentiment: Our primary sentiment model is Negative .

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.

  • Weekly Market Environment Model Reading: Moderately Positive