The fourth quarter is traditionally seen as a time to forecast and take a look at long-term indicators of where the markets are going. It’s also a time of reflection and looking back to see how accurate our previous forecasting turned out to be. Read more in this guest commentary provided by The FRED Report for The Street.
Here at the FRED Report, we view the end of the quarter as a time to reflect, examine long-term indicators and see where we are in the markets and how that fits with our views of where we should be. We also look at other forecasters’ views. In this article, we will discuss some of our longer-term indicators in conjunction with our "Fred’s Fab Four" article and videos given here on The Street, and see how things are shaping up.
Our first forecast was that 2011 would be a strong year in stocks, but that most of the gains would occur in the second half of the year. In addition, we forecast that the SPY would hit 130. We have tested the 130 area and are not too far above it. While this has been the strongest quarter for the Dow industrials since 1999, our proprietary indicators are suggesting the market is stretched enough to be vulnerable to a sharp two- to four-month correction despite the recent rebound. Some writers are forecasting strength into the summer, but we see a move back to test the 122 to 118 area on the SPY by June, i.e. the beginning of summer, and then a strong rally into the end of the year. In other words, this drop will not be the end of the world, and the gateway to a "new depression" — rather it will be a much-needed decline to reset our sentiment indicators and our own, proprietary momentum tools. We show a chart of our proprietary monthly Fred’s Price Oscillator (defined here) below, from November of 2002 – March of 2011.
Note that we are seeing enough of a divergence at a high level to signal a correction. Note also that the last correction, from April 2010 to July was around 20% and came from a high level (+15) on the oscillator. Levels of +15 are rare enough so that this one likely signals a multi-year bull market, with no sign of impending, multi-year bear. But a correction is certainly possible, even likely. When we combine this with over-optimistic sentiment readings, there is more cause for short-term concern.
One other area of concern we have seen is the U.S. Dollar Index. Many commentators are suggesting that a rise in the dollar will adversely impact commodity prices. Our favorite article in this regard is Harry Dent’s recent interview suggesting that an impending dollar rally is a reason to sell commodities. While Harry is correct to point out there has been an inverse relationship between the dollar and commodities, we think that is going to change in the second half of 2011. Why is this? We believe that fundamentals really matter for commodities. The economy should continue to expand, and should that happen, commodities will start to trade more on their own fundamentals of demand and supply, and less in relation to the currency. By the way, we agree with Harry Dent that the dollar is poised to rally. And, the DBC looks overbought enough to correct short-term. We show weekly charts of the Dollar and DBC below. We note that commodities, especially agricultural commodities and petroleum, have seasonal tendencies to correct into the spring. Should headline risk abate, these tendencies should reassert themselves.
Our forecast is that a correction in stocks and commodities could start in the next two weeks, and for a while the "doom and gloomers" will look like they are correct. This correction should end in a summer rally and a strong second half to the year.
This article was republished with permission from The Street.