What Do The Cycles Say About October?
Based on the early action, it appears that traders have moved into a schizophrenic mode as Tuesday's gains could be reversed quickly at the open.
At issue is the simple fact that no one really knows what to expect in terms of the duration of the government shutdown. And, the bottom line is markets hate uncertainty.
Optimism Fading Fast
At least part of Tuesday's advance was based on the idea that the government shutdowns since 1980 have not produced large sell-offs in the stock market. While the algorithms have been trained to react at the speed of light to any and all headlines coming out of Washington D.C., reports made the rounds yesterday that historically, stocks have managed to advance the vast majority of the time (ten out of eleven occurrences) in the two weeks following a government shutdown.
In addition, there was the Bloomberg report which stated that since 1976, the S&P has risen 11 percent on average in the ensuing twelve months following a shutdown. Given that such a return is actually higher than the average twelve-month period returns seen in the stock market, some traders may have decided to take a more upbeat stance - especially with the S&P having been down seven of the past eight sessions and having become oversold in the process.
Back To Reality - And the Debt
However, traders appear to be back to reality on this fine Wednesday morning. The fear is that with the political brinkmanship showing absolutely no signs of abating, the drama could easily continue for a while and eventually spill over into the debt ceiling deadline.
Frankly, the worry has always been about the debt ceiling. Treasury Secretary Lew said Tuesday that his department is taking extraordinary measures in its efforts to avoid running out of money the middle of this month, but that his options are running short. Since most traders likely remember that the credit rating of the U.S. government was stripped of its 'AAA' status the last time Congress failed to act on the debt ceiling in a timely manner and that stocks suffered mightily in response, traders appear to be heading to the exits at the present time.
Time To Review The Cycle Projections
Although the news of the day is likely to dominate trading in the coming days and weeks, investors should remember that the month of October has a bad reputation for generating large losses. So, with the market looking uncertain, it is time to review what the historical cycles have to say about the month October.
Since this is the tenth 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.
October Has a Bad Reputation
Most investors likely live in fear of the month of October as the month's bad reputation has been earned on the back of numerous market crashes over the years. However, it is important to note that when the market isn't involved with a horrific decline, October isn't half bad. But given the market's propensity to dive hard during the month, there are certainly some traders who enter October with a cautious stance.
Is The Market In Sync With The Cycle Projections?
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 September, it should be noted that the stock market went opposite the cycle composite's projection in the first half of the month and then got back in sync in the second half.
But from a longer-term point of view, the market (as defined by the S&P 500) continues to generally act in accordance with how the composite projection says it should in 2013. 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 October 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 not terribly positive. After a period of sideways consolidation in the first part of the month, volatility returns. And after an intense move in both directions two-thirds of the way through the month, a downtrend materializes that lasts until the beginning of November.
Four-Year Cycle: The four-year Presidential cycle projection is similar to the one-year, although the moves are more clear and pronounced. In short, the month opens with a rally and then the meaningful correction that began in August resumes into the end of the month.
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 end on a positive note (and with a plus-sign).
The Cycle Composite: The overall cycle composite suggests that October will be volatile with an early rally giving way to a stout pullback and then a modest rally into the end of the month.
So there you have it. It would appear that the cycles are suggesting that the current stalemate in D.C. will (a) continue and (b) produce some damage to investors' portfolios. Here's hoping that the projections are wrong and that the politicians come down off of their high horses sooner rather than later.
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. Fun and Games in Washington (I.E. the Gov't Shutdown and Debt Ceiling)
2. The State of Fed Policy
3. The Outlook for the U.S./Global Economy
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: Negative
(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 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: 1680
- Near-Term Resistance Zone(s): 1700
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: Neutral
- Price Thrust Indicator: Moderately Positive
- Volume Thrust Indicator:Neutral
- Breadth Thrust Indicator:Neutral
- Bull/Bear Volume Relationship: Moderately Positive
- 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.
- Overbought/Oversold Condition: The S&P 500 is moderately oversold from a short-term perspective and is neutral from an intermediate-term point of view.
- 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 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...
Not much new to report as the focus remains on the political games playing out in Washington. However, the ADP Employment report (which details job creation in the private sector) may provide a bit of a distraction given that the release of the monthly Jobs report is now a question mark due to the shutdown.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
- Japan: -2.17%
- Hong Kong: closed
- Shanghai: closed
- London: -0.54%
- Germany: -0.37%
- France: -0.61%
- Italy: +1.46%
- Spain: +0.17%
Crude Oil Futures: -$0.01 to $102.03
Gold: +$8.600 to $1294.70
Dollar: higher against the yen and euro, lower vs. pound.
10-Year Bond Yield: Currently trading at 2.648%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -7.35
- Dow Jones Industrial Average: -41
- NASDAQ Composite: -9.85
Thought For The Day...
Don't forget, ego is the real enemy in this game...
Looking for Guidance in the Markets?
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Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)
Positions in stocks mentioned: none
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