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What Are The Cycles Saying Now?

Daily State of the Markets
Wednesday, September 19, 2012

Good morning. With the market having pushed higher by a nifty +14.7% from June 1 through September 14, a move that was aided by the announcement of QE programs in both the U.S. and Europe, it isn't exactly surprising to see stocks stalling out this week. After all, since the most recent leg higher began, the market has been following a familiar pattern... blast higher on news, pause (or pull back for a few days), rinse and repeat. So, while the bears contend that this week's sloppiness is a sign of bad things to come, the price action itself lately has certainly been encouraging.

The great thing about using the price action itself as a guide is that unlike so many indicators, models, and/or chart pattern systems used to predict what is going to happen next in the stock market, price cannot diverge from itself. Sure, the price action can and often does appear to make little sense at times. But the simple fact remains that when prices move up it is a good thing for those who happen to be long the stock market and vice versa. And it is for this reason that I prefer to focus on staying in tune with the important trends in the market instead of making grand predictions based on my view of the world.

As I have mentioned a time or twenty, I'm not big on trying to predict what is likely to occur in the market. In my humble opinion, trying to consistently call the next move is a fool's errand. However, I am willing to admit that there are cyclical forces at work in the market and that these cycles oftentimes follow a similar pattern. Therefore, at least once a month, I like to check in on the various cycle patterns to see whether or not the current market rhymes with history.

To give credit where credit is due, I most definitely did not come up with the concept of creating a "cycle composite." No, it was the good folks at Ned Davis Research that developed the idea of combining the one-year seasonal cycle, the four-year Presidential cycle, and the 10-year decennial cycle of the market into a single composite. And while the composite isn't perfect (nothing is in this business!) it is eerie how often the market tends to follow the general direction of the cycle composite.

So, with the bulls having been on an impressive run of late (the S&P currently sports a gain of 16.2% year-to-date) and the bears telling anyone who will listen that the end is nigh, I decided it was time to look in on the cycle composite to see what MIGHT (note the use of capital letters) be coming next in terms of the market's overall trend.

Before I go any farther, let me say that this analysis is NOT part of our objective market models and that I will never make an investing decision based on what the cycles say. However, when things get dicey, it is nice to know what MIGHT (there are those capital letters again) be coming down the pike.

With the appropriate caveats aside, it is interesting to note that the cycles are suggesting the bears might have a case for the next month or so. In short, the cycle composite projects that the market traditionally pulls back in a meaningful fashion between the middle of September and the middle of October. This is largely due to the fact that (a) September tends to be one of the cruelest months of the year and (b) during election years, unless the incumbent party wins, stocks tend to decline during the September/October period.

The good news is the cycle composite suggests that any pullback that materializes between now and next month tends to be short-lived and then gives way to the traditional year-end rally. And for those in the bull camp, it is important to note that the cycle composite shows the market closing out the year on its highs.

So, how do you use this information, you ask? My thinking is that this type of data should be employed for "at the margin" type of decisions. For example, if you are currently underinvested and you believe that the Fed's QE program will continue to drive risk assets higher, then adding some exposure into any dip in the market makes sense. Or, on the other hand, if you find yourself with big profits and are feeling a little heavy, then taking some profits here and waiting for the dust to settle might make some sense. For me, I'm going keep it simple and follow my systems. But for new money looking to find an invested home, the cycles say that you may not need to chase prices higher here.

Turning to this morning... Although the Bank of Japan joined in the QE party by extending their asset purchase program, the stall largely continues this morning as European bourses are relatively flat and U.S. futures are fairly close to fair value.

On the Economic front... We'll get reports on Existing Home Sales as well as Housing Starts/Building Permits.

Thought for the day... Let him that would move the world first move himself. -Socrates

Pre-Game Indicators

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

  • Major Foreign Markets:
    • Australia: -0.25%
    • Shanghai: +0.41%
    • Hong Kong: +1.17%
    • Japan: +1.19%
    • France: -0.05%
    • Germany: -0.05%
    • Italy: -0.29%
    • Spain: +0.02%
    • London: +0.12%
  • Crude Oil Futures: -$0.74 to $94.55
  • Gold: +$2.50 to $1773.70
  • Dollar: higher against the yen, euro, and pound
  • 10-Year Bond Yield: Currently trading at 1.783%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: +1.23
    • Dow Jones Industrial Average: +26
    • NASDAQ Composite: +2.87

Positions in stocks mentioned: none

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