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April 29, 2012

Inflation on the Loose

I was wrong about the stock market. Expectations for a bit more of a correction have been debunked by recent action which shows the latest dip to be of the daily cycle variety rather than an intermediate decline. To be fair, the early stages of the decline possessed all the hallmarks of the commencement of a larger decline. A weekly trend line was broken in conjunction with a weekly swing high, and the cycle count was approaching Week 30. I have been writing in the Member Letter since December of my expectations to see the current weekly cycle run 30+ weeks and bottom in late April or early May.

The scenario calling for an intermediate peak in early April cannot be totally eliminated until that early April peak is exceeded. However, the current cycle setup in conjunction with the impending breakdown in the dollar... more below... suggests that stocks will continue higher.

SPX Daily

As you can see in the chart above, a required characteristic of an intermediate-degree declines is missing: a failed daily cycle. A daily cycle fails when price moves below the previous daily cycle low (DCL). I would also note that intermediate declines always take price below the 65DMA. The April dip did no more than back-test the moving average.

Interestingly, a friend of mine who goes by the moniker slr in Member comments has been warning on his blog that the April dip was of the sort he labels a fake bear. His volume studies suggested a minor profit-taking event. The updated cycle interpretation is now congruent with the fake bear outlook.

Furthermore, Tiho wrote a nice piece on his own blog over the weekend describing why market internals suggest stocks are now entering a topping process. The implication is higher prices in the near-term with the formation of a major top likely over the summer.

How high stocks could run is anybody's guess. Regular readers know that I despise the use of targets, but I must say that seeing the S&P 500 make a run at the 2007 high would not surprise me. The 1970s hosted several, large equity corrections, each of which ran the highs just befor rolling over again. We've already seen one such instance as the 2007 high barely eclipsed the 2000 peak. Perhaps the current secular bear will rhyme with the 1970s in this manner.

Before I move on to the dollar, a quick note about expectations and right versus wrong. Every time I miss a call about a market... especially about the stock market... worthless, crazed wackos tend to come out of the wordwork and taunt me publicly. By doing so, these people immediately reveal their lack of market prowess. Any seasoned trader will tell you that winning in the markets is not about being right, but rather about trading right.

The difference is huge. As I constantly describe to Members, developing trading opportunities is all about setting a framework of expectations. These are one's expectations for market action within the context of the framework of one's methodology... in my case, cycle analysis. We then judge market action against those expectations. If price movements are not behaving as they should, we receive a warning that something is awry. The setup can then be re-evaluated and updated. The recent action in the stock market is a perfect example. Stocks refused to break down at the 65DMA. Instead, price performed a successful bottom test and shot higher.

This development also occurred as the dollar behaved improperly. In cycle theory, a right-translated cycle should be followed by a cycle that sets a higher high. The DX completed a right-translated cycle at the end of February, so the current cycle should have popped above the January high before rolling over. We can now see that this rally has been aborted.

DX Daily

As mentioned above, a failed daily cycle signals an intermediate cycle in decline. Since the dollar's current intermediate cycle is only eight weeks old, the DX could be trending lower for a couple of months before it finds a footing for a solid bounce. The fact that the dollar could not muster a higher high on the heels of a RT cycle also suggests a very weak market. In other words, the coming decline could be quite devastating to the dollar.

The dollar outlook is critical to the commodity complex, including precious metals. Gold and commodities appear to be setup for a solid move higher, and I believe the rallies will be more fervent than most commodity bulls expect. The psychological setup is such that many traders are heavily long the dollar.

Aggregate dollar exposure

Once these traders realize they are on the wrong side of the dollar trade, they are going to panic out of dollars and into any real asset they can grab. Gold, for example, has a good chance at testing its all-time high as the dollar unwinds into late June.

I also mentioned that commodities in general are setup up nicely for a move.

Continuous Commodity Index Weekly

Of course, I should say a presumptively successful test, but with the dollar breaking down, I am confident commodity prices will hold and move higher. In fact, I would not be surprised to see that 8-week drip erased in half the time. A number of commodities, including coffee, natgas, sugar, cattle, and wheat have such dismal public sentiment readings, the snap-back rallies could be quite impressive.


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