COMBINING SUMMER RALLY AND FOUR-YEAR CYCLE SUGGESTS ANY JULY BOUNCE WILL BE FOLLOWED BY A WEAKER AUTUMN -- LIGHT TRADING VOLUME ON RECENT RALLY SHOWS LACK OF BULLISH ENTHUSIASM -- DAILY EMA LINES ARE STILL NEGATIVE
MOST OF SUMMER RALLY TAKES PLACE DURING JULY... My Tuesday message suggested that the "summer rally" may have started. I warned, however, that I thought that short-term bounce into July could be followed by a selloff into the autumn months. First, a brief description of the summer rally. The Stock Traders Almanac defines the summer rally as the distance from the low in May or June to the high in July, August, or September. The Almanac goes on to point out, however, that July is usually the strongest of the summer months (while August and September are the next to worst and worst months of the year respectively). That's why I suggested that any summer rally could last well into July. The summer rally, however, is usually the weakest of the seasonal bounces (only 9% on average). After that, seasonal trends turned negative into the autumn which could present a much better buying opportunity. That's because the four-year presidential cycle kicks in this October which usually marks an important bottom. The Almanac points out that the six months after that four-year bottom (November through April) are especially good. That's why I suggested on Tuesday that any summer bounce would most likely be followed by a retest of the spring lows. How does one play those two trends? While short-term traders might want to play a short-term summer bounce, longer-term investors might be better advised to wait until the autumn.
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Chart 1
A LOOK AT THE FOUR-YEAR CYCLE... The tendency for the stock market to bottom every four years is pretty consistent. Chart 1 shows the record back to 1982 for the S&P 500. The green arrows show four-year bottoms in 1982, 1990, 1994, 1998, 2002, and 2006. The only "miss" was in 1987 which occurred a year late (instead of 1986). The 1974 major bottom was also on schedule (eight years before 1982). Most of those bottoms occurred during October (2002 for example). Chart 2 shows the lowest low forming in October 2002 (as it did in 1998). In rarer instances, four-year bottoms have occurred during July and August (as in 2006). Chart 3 shows the market hitting a June 2006 low which was retested during July. An upside breakout took place during that August four years ago. While a major bottom could take place over this summer, odds favor the autumn 2010. Either way, an important bottom is due during the second half of this year.
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Chart 2
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Chart 3
DAILY EMA LINES ARE STILL NEGATIVE ... Another reader asked for an update on my favorite exponentially smoothed moving average combination which is 13 and 34 periods. First the short-term trend. Chart 4 shows that the 13-34 day EMA combination turned negative at the start of May and has not yet flashed a short-term buy signal. For that to happen, the blue (13-day EMA) needs to cross over the red (34 day EMA). The good news is that the weekly EMAs (which turned positive last July) are still positive as shown in Chart 5. [That good news is tempered by the fact that the monthly EMA lines (Chart 6) are still negative]. That combination suggests a watch and wait attitude for the time being (too soon to sell long-term holdings and too soon to initiate new short-term buys). Another reader asked if the relatively light volume shown in Chart 4 means anything. Light volume in a rally suggests lack of bullish conviction, and argues against this being the start of a major upturn. And, as Arthur Hill pointed out yesterday, that may explain why investors are still buying gold and Treasuries. Investors aren't ready to abandon those safe havens just yet.
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Chart 4
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Chart 5
