The Odds of a Santa Claus Rally are Good...

Mike Turner |

For the past several weeks, the time-cycle forecasts of the major US indexes have been somewhat mixed. The S&P 500, the DJIA, the Russell 2000, and the Nasdaq have all indicated a sell-off November, which we have certainly seen. But only the Russell has shown a continuation of that bearish trend into mid-to-late December. Now, all four of the indexes have come into reasonably close alignment with a consistent forecast of the market moving lower between now and late December, followed by a significant rally well into February, 2012.

But... what could go wrong?

Time-cycle forecasting is designed to give us an indication of how the stock market is likely to move over the upcoming 90-day period. True exogenous events can occur at any time, temporarily (operative word) pushing the market higher or lower. What I find interesting is when an exogenous event occurs, the forecasted relative change in trend and/or day-to-day amplitude, more times than not, proves to be accurate.

Here is what I mean...

Over the next 3 weeks or so, if the forecasts prove to become accurate, the market is likely to move lower. Then, on or about the 21st of December (again, assuming the forecasts prove accurate), the market will begin a very strong move higher that will last well into February. Now... Looking at the global economic and political landscape, can you think of anything that could 'surprise' the market... either to the upside or the downside? Further, do you believe it is within the realm of possibility that some kind of 'one-off' or 'once-in-a-lifetime' event could occur within the next three to four weeks? I can think of several that 'could' happen. It is anyone's guess as to how likely any of these exogenous events are to actually happen. Here is my list of potential exogenous events that could shift the market temporarily higher or lower:

  • A Middle-East crisis... Israel could attack Iran to take out their nuclear facilities. This would, of course, cause global markets to drop precipitously, at least for a short period of time. The odds are low that such an attack will happen within the next 90 days, but the odds are growing that Israel will not let Iran get a nuclear bomb, so it seems inevitable that some kind of attack will occur at some point... my guess is it will be sooner than later.
  • The ECB decides to back-stop the financial crisis in Europe... The European Central Bank has the ability to underwrite all the debt issues in the European Union, much like the US Federal Reserve has done in the US. However, there are major political issues in the way of this occurring. This means, to my way of thinking, that this is not a likely outcome... at least not within the next 90 days. However, should it occur, you could see the stock market rally higher and in dramatic fashion.
  • The IMF obtains sufficient funding to back-stop the financial crisis in Europe... This facility is already in place, but the IMF lacks sufficient funding (something easily resolved if the US dumps a few trillion fiat Dollars into the Fund) to effect a Fed-style bail-out of both sovereign and European bank debt. This is politically dangerous for Obama to do, but who knows if there is some kind of back-door credit-swap deal that could be done behind the scenes to provide the IMF (International Monetary Fund) with sufficient capital to become the lender of last resort for Europe. I actually think this has a relatively high degree of probability of occurring. I am personally opposed to the US bailing out Europe, but I have learned that some people will do anything to stay in political power. If Obama 'saves' Europe from financial collapse which will, in turn, cause the US stock market to scream higher as our economy grows stronger with Europe back on track to buy our goods and services, 2012 could be a banner year, economically. This 'could' give Obama a second term. Never mind the fact that such an outrageous use of political power forces the US taxpayer into massively deeper debt obligations by trillions more dollars. Never mind that this could move us closer to an economic Armageddon. If Obama is willing to forego our financial future by 'saving' his political future, then there is a scenario that would support a massive move higher in the stock market. Do I think this will occur within the next 90 days? I believe the odds are low, but certainly within the realm of possibility. When will we be told that "Europe is too big to fail..."? As an aside... Do you not think it odd that the so-called Super Committee failed to reach an agreement while Obama remained completely on the sidelines and nowhere to be found? Is it possible that if the committee had been successful in putting a lid on spending, that would have precluded Obama from massively increasing our debt in order to bail out Europe? Could all of his seeming "lack of leadership" just be a ploy to help orchestrate a far more insidious plan to save his presidency? Or, am I just giving him and his minions far too much credit for being that politically smart? I do not trust this President nor do I support his socialist political agenda. I believe he is capable of almost anything... and most of what he is capable of is not good for our country... in my opinion, of course. A quick note to my liberal friends... Please look up the definition of socialism and the term "socially responsible" before emailing me with your comments. I am continually amazed at how many liberals think my negative comments about socialism means that I am not supportive of being socially responsible. Socialism has NOTHING to do with social responsibility.
  • Finally, there could be an exogenous event that none of us (especially me, I suppose) could have foreseen... This is what makes the best definition of a one-off event. They could not have been predicted and come out of nowhere. Maybe China will do something significant that could be beneficial or hurtful to the stock market. Of course, there could always be some sort of natural disaster... after all, 2012, according to the Mayan calendar is supposed to usher in the end of the world on December 21, 2012. Then, there is Russia, Pakistan, India, North Korea, etc... any one of which could throw a monkey wrench into the global economic and political landscape.

My point...

My point is this... Exogenous events occur with an amazingly high degree of frequency. These events will skew the markets temporarily higher or lower, depending on the type and severity of the event. Forecasting market movement, based on time-cycle mathematical models, provides us with a clear picture of what is most likely to occur, sans a major exogenous event. What our specific forecasting model does though (and this is very important to understand) is to provide you with immediate feedback on what the market is likely to do in the near-term when an exogenous event does occur.

Below is a forecast of the next 90 days of the market as represented by the Russell 2000 Index (IWM):

As you can see, the forecast clearly shows the market moving lower into the third week of December, followed by a strong move higher into mid-February, 2012.

On the other hand, below is the current forecast of the Euro/Yen.

Here, we see an exogenous event unfolding (the green triangle). This currency pair should be trending higher (purple dotted line), but it is trending in the opposite direction (red dotted line). Our forecast model is telling us this exogenous event (whatever it is) will likely last, at most, only until December 5, 2011, at which time the currency pair will move lower until January 10, 2012, where it will begin a choppy rebound higher. I know of no other forecasting model that provides daily forecast adjustments due to perceived exogenous events. I am not nearly as concerned about 'what' causes the exogenous event as I am about the market impact of such an event.

These 'impact of exogenous event' forecasts are enormously valuable when it comes to trading. In the case of the above currency pair forecast, I can readily see the risk is high that if I were to take the short side of the forecast (red dotted line), I have a 50/50 chance of a 6% correction to the upside. This puts too much risk on the table to put on a short trade. On the other hand, taking the long side of the trade is going against the current trend, which has at least a 50/50 chance of continuing until the 10th of January. Absent any other compelling reason to be in this trade (long or short), I would avoid the trade entirely.

Now, let's move back to forecast for the Russell 2000 (see chart above)... I know, from historical accuracy percentages, that I have a 70% probability that the market will move lower between now and 21st of December. Further, I know there is a 9.57-day SuperCycle in play (you do not see this on the above chart... SuperCycles are provided to paying subscribers of the CycleProphet Tools service provided by CycleProphet.com). This SuperCycle starts on a specific day and ends on a specific day and in this case, is a "Bear Play" SuperCycle. Trading SuperCycles provides and even greater probability of success of the trade.

Armed with this information, along with support from other forecasts from the CycleProphet Tools, I have a fairly high degree of confidence that picking a Bear-Biased trade of an equity that has a high correlation to the Russell 2000 movement could result in profitable trade in the near-term... assuming no significant exogenous event, of course.

The above describes a small portion of the analysis that we go through on each trade we make. It is important to get as much on your side as you can when making a trade in the market. I am not a buy-and-hope trader or investor. I am more of a buy-and-sell kind of trader. I want to buy (or get into) a position with an eye to making a profit in as short a time as I can with the least risk possible.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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DXLG Destination XL Group Inc. 4.19 -0.13 -3.01 272,654

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