I Don't Like Forecasts, But...

By David Moenning

Daily State of the Markets 
Thursday, January 31, 2013

Good morning. I'm short on time this morning (I'm running to the airport in a few minutes), but I wanted to give you an update on our cycle forecast (and confirm the fact that I am not permabull). But before I do, let me once again say that we do NOT make buy or sell decisions based on ANY kind of predictions. No, we focus on what IS happening in the market and depend on the readings of our Market Environment Model to guide our exposure to market risk on a daily basis.

With that said however, I should also point out that our cycle forecast is indeed one of the 10 inputs to both our daily and weekly Market Environment Models. You see, I've discovered over the years that the markets do tend to follow certain patterns at times. In fact, the vast majority of the time the cycle forecast is pretty darn good in terms of calling the general direction of the market. As such, I do like to pay attention to the overall trend being forecasted by the composite - especially when the cycles are calling for a change.

But let's be clear about one thing: I am NOT suggesting that anyone should invest according to what the cycles say. No, as I've said a time or two hundred over the years, I believe that the best way to succeed in the long run is to have an investing strategy/discipline and to stick to it. Although markets can make any strategy look silly at times, I sincerely believe this is the key to long-term success in the stock market game.

As you may recall, our cycle forecast combines the 1-year Seasonal, the 4-year Presidential, and the 10-year Decennial cycles into a single composite forecast. And as I detailed a few weeks back, the cycle composite is one of the most popular things I write about. So, when the cycle composite suggests that a trend change may be at hand, I figure I should let people know about it.

Just so there is absolutely no chance whatsoever that I can be misunderstood; I'd like to add one additional caveat. While the cycle composite does a pretty good job at calling the general trend on a longer-term basis, it can get COMPLETELY out of whack with reality at times on a short- or intermediate-term basis. As such, we have got to take any near-term "calls" with a large block of salt.

But here's the bottom line: the cycle composite suggests that February could get nasty. The composite itself shows that the S&P 500 could decline for the vast majority of the month and actually wind up pushing the index to the lows of the year. And given that we've enjoyed very strong gains in January, this might cause investors a fair amount of discomfort.

The good news is that the components of the cycle composite offer differing views here. While the 4-year Presidential cycle points to a very ugly February, the 1-year is another story. In fact, the 1-year cycle points to additional gains in the first part of the month to be followed by a sideways period, and then a modest decline heading into March.

So... Given the projection of the cycle composite as well as the facts that (a) stocks are overbought (the bears have been completely shut out of the game for the better part of the last two and one-half months), (b) sentiment has become overly optimistic (our sentiment indicators are now negative on balance as a result - but, of course, they can stay that way for quite some time), (c) there is serious resistance overhead (the all-time highs for the Dow and S&P 500), (d) suddenly the health of the economy can be called into question (yesterday's GDP report was indeed a surprise - and not a good one), and (e) the politicians in Washington are due to take center stage again in the coming weeks, it is safe to say that stocks are "set up" for a pullback. And if the bears can find another negative catalyst or two in the coming days, well, our furry friends might just make the cycle composite come alive.

Then again, perhaps this will be one of those times when the cycle projection gets