And, of course, the fact that we're in the midst of a secular valuation contraction during Year Four of the Four-Year Cycle increases, rather than decreases, long-term risks.
The Market Now. We are in Year Four of the Four-Year Cycle, when bad things -- and, sometimes, very bad things -- traditionally occur, and the fact that we are in the midst of a secular valuation contraction increases the long-term risks even further. The uptrend of the past few years is giving way only very, very reluctantly, though, as is almost always the case with uptrends of this magnitude, and the fact that our economy is relatively stronger than other global economies is undoubtedly a major factor in this. Lowry's, though, is very unhappy with the current market internals, and a close below 1394 would generate a short-term reversal which would have especially negative implications if the financial sector turns relatively weak in the process. A close below 1266, meanwhile, would have at least intermediate-term consequences. Whatever may or may not happen over the short-term, though, long-term risks are unacceptably high.
David Fuller's view The Fullermoney online Archive contains 13 entries on the secular valuation contraction which I most recently discussed on Tuesday, 31st July 2012. This link will require subscription registration but occasional visitors to the site can access some of the earlier ones, should they wish to. Just use the 'Search' facility shown upper left, fourth item down.
Walter Deemer has a number of interesting comments on both the secular valuation contraction cycle and what he refers to as "Year Four of the Four-Year Cycle." Both of these subjects may appear somewhat esoteric to readers, at a time when commentators are focussed primarily on the latest can-kicking exercise in Euroland, China's slowdown and the USA's approaching "fiscal cliff", as Mr Bernanke described it.
My advice is to watch the price chart action because it will provide, more often than not, those rare moments of illumination. The latest 'surprise' in this respect is the ranging stock market rally which was signalled two days after the low at 1266 by that clear upward dynamic in 6th June, as you can see on this daily chart of the S&P 500 Index.
A close beneath that low at 1266 would indeed have consequences, as Walter Deemer points out, although we would see the next evidence of technical deterioration much sooner, thanks to the orderly progression of rising lows evident. Currently, a close beneath the last reaction low at 1355 would provide the initial evidence of pattern deterioration, should it occur. Meanwhile, the rally has done rather well in regaining this year's earlier highs and the choppy medium-term trend is back above its 200-day moving average, which is also rising as you can see on this weekly chart.
What about that four-year cycle? I confess to being a philistine on the subject, except that it coincides with the US election cycle. My recollection is that, on average, the US market has been stronger following a reaction low in the third (pre-election) year. If so, the latter portion of the third year strength usually produces a gain in the election year as well, especially if the White House and an accommodative Fed are stimulating the economy. That rally can carry on into the first year of the new election cycle, until the elected administration and Fed change policy in an effort to clean the Augean stables of excesses.
Unfortunately, but perhaps unsurprisingly, this pattern can vary considerably because there are so many other influential factors for investors to consider. Walter Deemer's "…bad things - and, sometimes, very bad things" certainly occurred in the election year of 2008. However, if you look back on earlier election years, 2004 was bullish, as you can see on this historic semi-log chart of the S&P. The year 2000 saw another very big downturn but 1996 was certainly bullish, as was 1992 and 1988. (Note - it will be easier to see the election year variations if you recreate this chart in the Library and use the 'Tracker On' facility.)
Returning to this election year for the S&P, there is little evidence of investor euphoria despite a gain of 11.5 percent to date. Therefore, even though we are back at previous resistance from the year's earlier highs, and somewhat overbought in the short term, I will continue to give the upside the benefit of the doubt until the current progression of higher reaction lows evident on the daily chart above is broken. Meanwhile, commonality shows that some other leading markets for this cycle, from several ASEAN indices, including Singapore recently, to South Africa and Mexico have also moved to new highs for the year. Within battered Europe, Denmark broke to a new high for the year before encountering some resistance at the psychological 500 level and several other European indices are within striking distance of their 2012 to date highs.