January 2011

Sub Cycles

The S&P 500 continued its remarkable run from the August lows gaining 2.37% in January and putting in play the old adage: 'so goes January so goes the year'. You can see our results on our performance page. As I mentioned last week, the averages defy what's happening beneath the market and begs the question as to whether the S&P and the Dow are merely playing catch up or is something more ominous is about to happen. I believe the former is true and call on statistics and thoughts from my friends at BCA and Lowry research for my rationale.

• Although downside risks persist (housing, rising oil and food prices, budget cutting) the economy now appears to be on a self-sustaining recovery despite the fact that monetary conditions will remain accommodative at least until next year. 'Don't fight the Fed'
• The output gap (measures excess capacity) remains six percent below GDP. This should keep core inflation down, along with interest rates; two determinants for a healthy stock market.
• While Emerging markets may continue to lag developed markets over the short term (central bank tightening), they remain structurally sound and remain in a secular bull market.
• Although emerging country demand should keep commodities in a bullish uptrend, they look a little tired in the short run. Gold looks to have plateaued, but with interest rates remaining low, political tensions high, and mounting deficits, it remains a core holding.
• From a technical standpoint, rising buying power and shrinking selling pressure indicate that we are still in phase one of a three phase cyclical bull market. Even if we are about to go into phase two, historically we may still have another sixteen months of positive performance.

As a chart junkie, I find the chart below (courtesy of the Chart Store) fascinating. Notice that the past two secular bear markets ('29-'49 and '66-'82) contain four sub cycles. We have completed two cycles of the current secular bear market, and therefore can expect one more down wave, an up wave and a final down wave before this secular bear market plays itself out. Fortunately, as seen below, the last two cycles generally have milder bear phases.

Please click link to view chart: Sub Cycles Chart

-Joe