Daily State of the Markets

What Do The Cycles Say About December?

It safe to say that 2013 has been an interesting year. The bears have clearly been frustrated due to the straight-up nature of this year's move and the fact that the vast array of the negative macro prognostications from the beginning of the year failed to materialize. But despite the big gains seen in the major indices, a great many bullish investors are also frustrated – because they didn't catch as much of the joyride to the upside as they could/should have.

However, one of the most important attributes to have in the business of investing is a short memory. The great thing about the markets is that the ringing of the NYSE opening bell provides investors with the opportunity for a fresh start each and every day. And as professional managers and individual investors alike recognize, looking ahead to what the next day, week, and month may bring seems to be even more important at this time the year.

With gains of greater than 25 percent in the major stock market averages, a great many investors (including yours truly) would probably like to bank the profits and call it a year at this point. But the bottom line is this is a game that never ends and there is still some time on the clock for this year's contest. As such, it is time to review what the cycles look like for the final month of the year.

Time To Review The Cycle Projections

Since this is the twelfth review of the cycle composite this year, there is probably little need to go over all the disclosures/disclaimers again. The bottom line is that analysis of cycles should not be used in a vacuum or as a stand-alone indicator. However, the data continues to be an important input into our daily and weekly Market Environment models.

For anyone new to this analysis, the cycle composite is a combination of the one-year seasonal, the four-year Presidential, and the 10-year decennial cycles – all going back to 1928.

December Tends To Be Strong, Especially When…

Even casual investors are likely aware that the month of December tends to finish in the green. Most investors are probably also aware of the fact that there is traditionally a move higher from the November/December low into the first quarter of the next year. Call it the Year-End Rally, or the Santa Claus Rally, or the "January Effect" or whatever you would like. The key is that stocks tend to move up at this time of year.

This is especially true when the S&P 500 has enjoyed a gain of 20 percent or more through the end of October. According to Ned Davis Research, there had only been fourteen such occurrences prior to this year since 1927.

The good news is that of those fourteen other years when the S&P has surged through the first ten months of the year, December has finished higher in 86% of the them. Yep that's right, December has been higher twelve out of fourteen times – and produced an average gain of 2.88 percent in those up years. It may also be reassuring to note that the two losing Decembers produced declines of just -0.6 percent and -1.2 percent respectively.

So, while stocks are overbought and could easily correct, you can't really be blamed if you are feeling good about stocks right about now.

Is The Market In Sync With The Cycle Projections?

Moving on, the first step in the analysis of the cycles is to get a feel for whether or not the cycle projections are "on" or not at the present time. Looking at how the market acted relative to the cycle composite in November, it should be noted that the stock market went the exact opposite the cycle composite's projection last month.

But from a longer-term point of view, the market (as defined by the S&P 500) continues to largely act in accordance with how the composite projection says it should in 2013 (although the index is a bit higher than the projection at this time). And in looking at the market versus the projections since 2009, it is clear that the S&P is fairly close to where it is projected to be.

What Does December Look Like?

The next step is to take a look at what the cycle projections are calling for during the coming month:

One-Year Cycle: The picture painted by the one-year seasonal cycle is pretty good overall. The one-year cycle calls for an advance into the first week of the year to be followed by a fairly stiff pullback that lasts into the Christmas Holiday. From there though the usual year-end markup periods sets in and the index finishes higher.

Four-Year Cycle: The four-year Presidential cycle projection is not nearly as rosy as the one-year. Like the one-year cycle, the month opens with a rally and then encounters a meaningful correction that takes the index down to the fall lows. From there, the usual year-end rally occurs but the move isn't enough to keep the index from finishing in the red.

10-Year Cycle: The good news is the 10-year cycle looks very different from the one- and four-year cycles. The 10-year suggests the month will be more of a sideways affair and then end on a positive note (and with a plus-sign).

The Cycle Composite: The overall cycle composite suggests that December will be somewhat volatile with an early rally giving way to a stout pullback and then a decent rally into the end of the month.

So there you have it. History, as well as most of the cycle work, suggests that December should be an enjoyable affair. But investors should be on the lookout for an early pullback and then be ready to get onboard the year-end rally train in the last week of the year.

Next time, we will take an in-depth look at what the four-year Presidential cycle says is in store for early next year. But here's a hint, it ain't pretty!

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 Policy
      2. The Outlook for Economic Growth
      3. The State of the Bull Market

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: 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 12 months)

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:

  • Near-Term Support Zone(s) for S&P 500: 1800, 1780
  • Near-Term Resistance Zone(s): 1808-1813

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: Moderately Positive
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator: Neutral
  • Breadth Thrust Indicator: Positive
  • Bull/Bear Volume Relationship: Moderately Positive
  • Technical Health of 100 Industry Groups: Neutral

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.

  • Overbought/Oversold Condition: The S&P 500 is moderately overbought from a short-term perspective and is overbought from an intermediate-term point of view.
  • Market Sentiment: Our primary sentiment model remains 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 because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.

Weekly State of the Market Model Reading: Positive

If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.

Turning To This Morning…

Although Goldman has announced it is now positive on China for 2014 and Asian markets were largely better overnight, weakness in stock markets across the pond is weighing on U.S. equity futures in the early going. A downgrade of French equities in conjunction with the general weak economic outlook (there is more talk of rate cuts being needed in Europe) has traders leaning bearish in Europe. As a result, S&P futures are pointing to a negative open on Wall Street.

Pre-Game Indicators

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

Major Foreign Markets:
– Japan: +0.61%
– Hong Kong: -0.53%
– Shanghai: +0.71%
– London: -0.82%
– Germany: -1.04%
– France: -1.63%
– Italy: -1.03%
– Spain: -1.00%

Crude Oil Futures: +$0.22 to $94.04

Gold: +$0.90 to $1222.90

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

10-Year Bond Yield: Currently trading at 2.794%

Stock Futures Ahead of Open in U.S. (relative to fair value):
– S&P 500: -5.40
– Dow Jones Industrial Average: -57
– NASDAQ Composite: -3.40

Thought For The Day…

If you don't like something, change it. If you can't change it, change your attitude. -Dr. Maya Angelou


Wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist

Positions in stocks mentioned: none

Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them in the stock market during bull markets and on the sidelines (or short) during bear markets. The Daily Decision System Can Help

For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)



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About the Author

David Moenning is the Chief Investment Officer at Sowell Management Services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 29 years.