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Is a Consolidation Period Lurking for Markets?


If the trends do not continue to expand and break down, the answer could be yes.

The best thing one can do when it is raining, is to let it rain.
-- Henry Wadsworth Longfellow

In last week's article, I discussed the ~88% correlation of the Fed's balance sheet to the S&P 500 Index (INDEXSP:.INX) since the 2009 market bottom. I opined that if the Fed stops pumping cash into the system – what's now being referred to as tapering – the probability is that there will be a correction in the general stock market. Continuing this thought, today I will comment on the recent volatility and expansive moves within the period.

The period under discussion stems back to the 2009 bottom and transition from a cyclical (one- to four-year) bear market to a cyclical bull (illustrated in the previous chart). What's also evident are the three distinctive trends since this transition occurred (A, B and C). 'A' is considered the cyclical bull trend; 'B' and 'C' are the secondary and tertiary trends within. What's worthy of attention is how, in a bull market, the trends will continually expand at a greater rate until they are finally exhausted.

The October 2011 bottom (post-Greek debacle) changed the trend from A to B as the market began to expand at a greater rate due to broadening investor confidence and further quantitative easing. In the same vein, the November 2012 low (amidst the fiscal cliff debacle) again shifted the trend from B to C and once more, increased its slope (return average per month). Since this last transition the market is up 21.5% in nearly seven months.

When examining the market closer (daily chart), it becomes apparent that a quaternary period has appeared (trend 'D'), originating from the mid-April sell-off. Albeit distinct, the market has already broken this and has come to re-establish support back on its prevailing C trend, right at its 50-DMA (day moving average). This analysis is, in its simplest form, very powerful information when considering the end of market cycles begin with the non-continuation of trend expansion. Otherwise stated, if the trends do not continue to expand and break down to their previous trends, it is a signal that a consolidation period may be lurking around the corner.

As every investor is aware, the S&P 500 has multiple declines per year to the tune of 5-10%. These short-term corrections can lend opportunity to an otherwise volatile market. However, if the rain continues to pour and there is no further expansion once a consolidation period has concluded, it will more than likely lead to a much greater loss to the tune of 20%-plus.

The typical term used for the quaternary D expansion is a "buying climax." These are contrarian warning signs of everyone being on the same side of the fence – all buyers and no sellers. Now that it has concluded, investors should watch for further expansion or a break of trend C. As we enter the summer "slowdown" months, it is important to be alert. If trend C breaks, trend B is near the 200-DMA (~1,500), another 10% decline from current levels.

I hope this helps and finds you well

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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