What Do The Cycles Say for May?

Greetings from Santa Marghareta, Italy (yes, where the Pinot Grigio wine originates - and yes it is MUCH cheaper here - €6.99 vs. $24 at my local store in Colorado!). In light of the facts that (a) I am traveling and (b) the markets have been fairly positive lately, there really isn't much analysis that needs to be done as it relates to the "state of the market." In short, another central bank has recently joined the QE party and that means even more money will soon be "sloshing around" the global financial system. And given that the U.S. stock market seems to be the investment of choice for at least some of that cash (especially those with the ability to do "carry trades" in foreign countries such as Japan), I'm of the mind that the bulls should be given the benefit of any doubt right now.

But since I've got some time on my hands this evening (the Cinque Terre trails are apparently not yet fully opened, so there will be no hiking today), I thought I'd send along an update on what our Cycle Composite says about the month of May.

I know that I've been writing about the cycles more than normal this year. But since the cycles have been largely "on" for the past 4 years, I feel it is important to keep up with what history says "could" happen next - at least as far as the cycle composite goes, that is.

As I explained last month, the projection of the Cycle Composite (which includes the 1-year seasonal, the 4-year Presidential, and the 10-year decennial cycles) is one of the inputs to our Market Environment Model. While I would never trade solely on this indicator, it has proved to be very useful on occasion. As such, I am willing to give it a 10% weighting in our models.

Before I get to the projection for the month of May, I should let you know that, generally speaking, the composite of the three historical cycles has been fairly spot on since 2009. Yes, there have been exceptions and some stumbles. But overall, it is an input worthy of consideration.

For example, in the fall of 2009, the cycles called for a larger decline than what actually occurred. Next, the decline the market experienced in the summer of 2011 was earlier than the cycle had projected - but this was due in large part to the fact that the Europe debt crisis that was running the show at that time. Then in 2012, the cycle composite called for a larger decline than what took place. Oh, and the market did dip more than projected around the time of the Fiscal Cliff debacle. Finally, the composite did call for a larger decline in March this year than what we saw. But all in all, it's been a pretty decent indicator for a fairly long period of time.

So, what does the cycle composite call for in the month of May? Perhaps the biggest takeaway is that those calling for the "Sell in May and go away" trade to work yet again, could be disappointed. You see, the cycles say that the S&P should be up in the first week of May (check) and then succumb to a modest decline in the middle of the month. And then after that, the bulls are projected to be large and in charge for the remainder of the month.

Looking ahead, for those of you looking for the traditional "summer swoon," it might be time to try something different this year. In short, the cycles are suggesting nothing but green screens all the way into the middle of July. Well, to be fair, there are a few little hiccups that are slated to occur along the way - just nothing in the way of a meaningful correction.

So... Assuming the market continues to mimic the general trend of the historical cycles, I'm going to stick with my theory that no new crisis means that there will be no serious decline in the near term.

And what if the cycles are wrong, you ask? This is why we utilize a series of models to guide our investment exposure instead of relying solely on historical projections. The bottom line is that if the models begin to break down, then we will reduce our risk profile correspondingly. But for now, I believe there is a bottle of Santa Marghareta calling my name (it is 6:00 pm here after all!).

Posted to Investing 101 on May 21, 2013 — 4:05 PM
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