At this time of year, opinions, theories, and prognostications regarding what to expect in the stock market are everywhere. By now I’m sure you’ve heard what the likes of Goldman Sachs, Morgan Stanley, Meredith Whitney, the boys at PIMCO, Barron’s, Nouriel Roubini, and even some guy named Celente (who happens to make Roubini look optimistic) have to say. So, since we don’t make predictions, we thought it might be time to check in with our historical cycles to see what they might project for 2011.
However, before we embark on the process of analyzing the various cycles, we must provide one very important caveat. While the cycles are oftentimes dead-on in terms of accuracy, we don’t use them to manage money.
As I’ve mentioned a time or twenty, we believe it is much more important to stay in line with what the market IS doing instead of what we think it “ought” to be doing! After all, this game isn’t about being right or grabbing headlines, it’s about making your account go up. And it is has been my experience that people don’t give a hoot HOW you get it done, just that you do.
Another thing I’ve learned over the years is that when something works, people tend to jump on the bandwagon. Since the cycle analysis we follow does tend to work more often than not, it is something that I like to review at least once a month. As such, I’m guessing I’m not the only one to do so.
What I’m talking about here are the historical cycles in the stock market. Everybody knows that January is one of the best months of the year for the stock market and that the old cliché “sell in May and go away” tends to work on occasion. And I’m guessing that most folks are aware of the fact that the September/October period isn’t always kind to investors.
However, we’re not talking about monthly tendencies for the market but rather longer-term cycles such as the one-year seasonal cycle, the four-year Presidential cycle, and the 10-year decennial cycle. And instead of looking at these cycles individually, we prefer to look at these three cycles on a combined basis.
As with most things that are really nifty in the market, I can’t take credit for this concept. No, it was the deep thinkers and the computers at Ned Davis Research that pioneered this idea.
While everyone knows that history doesn’t repeat itself exactly, as the saying goes, it often rhymes. And having looked at these cycles for many years now, I can say that there are likely legions of hedge fund managers looking at these historical guides. So remember, if enough people look at the same research, the outcome can become self-fulfilling.
Regardless of why it works, the composite of cycles do seem to work quite well – when they do, of course. For example, in 2009, the cycles said that stocks would waffle for the first couple of months (check), rally hard into April (check), decline into the fall (check) and then rally furiously into the end of the year (check).
While the cycle did a good job overall, it should be noted that there were a couple of periods where the market went completely opposite the cycle’s projections. For example, stocks fell into February instead of rallying from the middle of January. Ditto for the month of August. And truth be told, stocks did begin to rally about a month earlier than the cycle called for. However, the general trend of the year wound up being pretty much spot on.
So what does the conglomerate of cycles say about this year? Unfortunately, I’ve got good news and bad news. The good news is that the cycle says stocks should basically soar (after a sloppy period in mid-January) into February and then continue to work higher in a choppy fashion into early May.
But, before you consider invoking the “Sell in May and go away” rule, you should know that after a meaningful pullback in May, the cycle suggests that stocks will continue to rally and wind up making new highs throughout the summer.
Now for the bad news. Beginning in early September, the cycle composite calls for a stiff decline. And while the duration and depth of pullbacks projected by the cycles are always open for interpretation, it looks to us like this correction could wind up wiping out a very healthy chunk of the gain for the year. But then after the stair-step move lower into early December, we should expect to see a relief rally to finish out the year.
The bottom line is the cycle composite says it will be an up year. However, the composite also tells us to not become complacent and to be on the alert for at least 3-4 major downdrafts. So, given that investors tend to overdo everything in the stock market (in both directions) we will continue to watch the sentiment indicators for signs that the froth is getting out of hand in the next couple of months.
But until then – or until something comes along that causes traders to toss historical tendencies aside – we should enjoy the ride.
Finally, it is important to recognize that we are not out of the woods from a very short-term perspective. History shows that things usually wind up being on the sloppy side for another week or two before the rally resumes.
So… IF (a big IF) history either repeats or even rhymes, we have some good times ahead before things get ugly later in the year. And what if things don’t go according to plan, you ask? In short, this is the reason we don’t depend on a crystal ball to make investing decisions! As always, we’ll let our indicators dictate our allocations and timing.
S&P 500 - Last 5 Years
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