Looking Ahead to 2014

To wrap up our end of year/beginning of year analysis, I think its important to take a step back and look at the long term uptrend in the market and identify what is currently going on and what needs to be highlighted moving forward.

When we look at the SP500 on a long term view its important to realize where the true turning points could be, as well as where a potential correction is likely to find buying support. Being that the market is up so much over the last year, we could see a large correction of 15-20% and still be within the long term bull market uptrend. I have two primary support levels that I am watching very closely; the lines in the sand, if you will.

 The first "line in the sand" is the area we are most familiar with when reading over our weekly reviews.

 The intermediate term uptrend from November 2012 to our current date is the more aggressive trading support. Meaning that stocks can be heavily owned above these levels; the primary support of interest is the intersection of the uptrend support line, the rising 20 WMA and recent consolidation lows at 1,767-1,747. A clean break of that area of support that violates all of these levels of interest would be enough to seriously alter our current market exposure in the near term. The lower end of this support range will likely continue to rise as that currently corresponds to the rising trend support line and 20 WMA, those will likely be closer to the 1,767 swing low by the time any real threat to that area comes into play. So for now, focus shorter term positions against the 1,767 support low. If that low fails to hold on a pullback, we would likely need to play much more defense than our current allocation suggests.


The second key level for the market really is the BIG ONE. If this support zone fails then the entire validity of the bull market comes into question. To get the right view of the support we have to look at a Monthly bar chart going back to the 2000 highs.

 If we highlight the prior range highs, a "retest" of that inflection point would occur at the 1,570 area and even extend down to about 1,535. We then look to the rally support off the 2009 financial crisis lows which intersects our support band and nearly matches the 20 Month Moving Average. This confluence of support signals suggests that this "retest" scenario would present a fantastic risk/reward buying opportunity, but also is the long term line in the sand for stocks moving forward. We would want to be focused on equities above that support area and likely sell out completely from any Long exposure to stocks below it.

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Now that we have a very clear view of where our risk levels reside, we should also take a look at an interesting view of the SP500 that I have been noticing recently. This is a hypothetical scenario and should not be considered as a viable investment plan, but it does present an interesting outlook going forward for the market. If you want a prediction from me heading into the new year, this is as close as you will get...

It is commonly said that history repeats itself. I tend to feel that historical pattern recognition, whether it be financial markets, politics or general human interaction, tends to rhyme more than it repeats. Saying that something will occur exactly like it did before is a little silly, but understanding that a similar outcome could come to pass is reasonable. With that preface in mind here is a situation evolving right now that I feel could have a similar "rhyme" to it.

Looking at our recent market history, it is clear to see that after being sideways for the better part of the last decade, stocks seem to be attempting to push higher out of this sideways range. Many market participants feel that seeing that we have moved such a great distance off the bear market lows in 2009 that the market simply can't continue much higher without another "crash" situation. But if you use history as your guide and look for patterns in the price, its interesting to see that this recent 10-13 year range we have been in is strikingly similar to the market view from the mid 80's into the early 90's. Which was right before US stocks took off, climaxing in an amazing bull market peak in early 2000.

Lets take a closer look at these two periods.

First we look at our current environment. Within the past 13 years we have seen two quite similar  +50% declines for the SP500. They both took roughly 2 years from peak to trough and both declined a similar amount. We have recently seen a very solid breakout and follow through from this range suggesting higher prices to come...But how much higher is possible?

For that, we turn to the pattern from the 80's which I feel holds more information as to what is possible for us next in the stock market. While many "main street" folk are beginning to venture back into stocks, people still seem generally distrusting and disinterested with the market. This is one reason why I think we could possibly have lots of upside to come in the future. The financial media has grown incredibly short term in nature and are constantly fixated on the daily ups and downs in prices. I feel they lose the forest for the trees and are not considering the possibility just how much better things could become before this rally comes to an end.

The time period from about 1986 to 1991 seems very similar to where we are currently. The reason I say that history rhymes and doesn't exactly repeat can be seen by comparing these two charts. In our current environment the sideways trading has lasted more or less 10 years, while the comparison view only took 5 years to play out. Our current range had two roughly 50% declines and covered 2 years each. The previous range saw losses of 20-30% and lasted about 6 months peak to trough. While the decline amount and length of the moves was dramatically different, the same psychological effects of the price movements takes place. Prior to each decline prices rallied strongly and then went through a bear market decline (a bear market is usually defined by a correction of more than 20%). Investors were elated at the peaks and desolate at the lows. Yet each decline brought about a new, refreshed rally that made up for all the prior losses. We then see the cycle repeat. And we may be seeing it happen again in our current environment.

What the comparison is meant to show is that regardless of the dates attached to the bottom of the charts, investor (human) psychology does not change. During the bear markets in the 80's and into the 90's the US saw very high unemployment levels, was involved in the Gulf War and uncertainty was amok. Yet once the issues slowly resolved and the economy began to turn, markets rallied for 20 years to heights not imaginable except in hindsight...

  
Here you can see the remarkable rally and the prior consolidation base we have been looking at. To compare where we currently would find ourselves based on a rhyming scenario would likely be somewhere in the breakout surge in 1996. This prior pattern would suggest that dramatic upside could still be in store for stocks over the next decade or two.

The US will be going through a similar demographics phase beginning in the next 10 years that was very much like the Baby-Boomer's rise to power. We are the Boomer's kids, we happen to be larger in the number of people that were attempting to enter the workforce in the late 80's and could see a similar economic spike once we gain stable employment and reach our peak spending ages; this is typically defined as from our early 40's to mid 50's. That is the age where most of the age group is fully employed and looking to upgrade to their 2nd home as their children begin to head into teenage years. We have reached a higher income level at that stage and is typical that we buy new cars, new homes and continue to be spenders in a consumer based economy.

While that's quite an economic theory and based entirely on the past, so far the technical patterns we are seeing suggest more upside to come. It might just roll over and play dead in the next year or so and all of this is rendered worthless. Or we might just be entering a new chapter in the continued strength of the US economy and be setup for dramatic upside in the not so distant future.

Again I'm not one for predictions in general, I just thought this historical context was interesting for where we currently sit with so-called "elevated" stock prices. Am I basing my investment strategy on this theory? No I am not. I continue to defer to what price is actually doing and not what I think will happen. But this is an interesting nugget of information that we shouldn't just ignore and pretend the past doesn't matter.

This will wrap up our year in review/preview series and beginning next week we will get back to our standard format of following our watchlist stocks and continuing to use Relative Strength as our guide.