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The Next 6 Months

Posted By Barry Ritholtz On March 8, 2004 @ 3:28 pm In Finance | Comments Disabled

Given the rotation the market has been enduring lately, we thought it might be helpful to assess where the major indices are at present, looking out 2 quarters into the future. This is less an exercise in prediction making, and more an assessment of how the present market cycle might play out, based upon historical precedents.

Following a huge influx of cash at the start of the year – $40.8 billion in January alone – markets rallied until January 26. At that point, the Nasdaq peaked and reversed, while the Dow and the S&P formed a temporary top (See our January 22nd comments, “Market Flashes Yellow Caution Light [1]“). They have not pulled back as aggressively as the Nasdaq did, and have stayed within striking distance of their 52-week highs. Indices such as the S&P SmallCap 600 Index (IJR [2]) and the S&P MidCap 400 Index (IJH [3]) continue making new 52 week highs, while their larger cap brethren have stalled.

The $40+ Billion dollar mutual fund inflow matched levels not seen since March 2000. A contrarian’s instincts should, at the very least, presume this surge of investor bullishness, coming at the tail end of a terrific rally, is an event likely setting a short-term top. Since then, the data [4] suggests that inflows have dropped by over 50%. Comparing the present environment with the one from a year ago, we observe:

1) The market was very oversold then. Today, it is actually somewhat overbought; 2) Valuation was compelling a year ago; Now, there are far fewer “cheap” stocks; 3) Within the broader Market Cycle, equities were at a post-bubble lows in March 2003. After last year’s rally, we should expect a sideways consolidation for some period of time; 4) One year ago, economic data was at cycle lows. Recently, ISM data hit 20-year highs – and then rolled over.

These observations, however, do not suggest that the present rally is over. To the contrary, the Dow and S&P500 have yet to experience a 5% pullback. Until that happens, our working assumption is that we do not know when or where this rally will ultimately end. Historically, the first SPX/Dow pullback occurs halfway to two thirds of the way through the run – On average, at about the 60% point.

Until we experience an an initial retracement, our premise is that any pullback is part of a consolidation process, which could last up to 4 months. Once a 5% move occurs, we would expect at least one more leg up. If the first part of the rally scored 60% of the gains over a year, we would expect the remaining 40% move to take place over an 8 to 15 month time frame, complete with periodic spikes and sell offs.

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2004/03/the-next-6-months/

URLs in this post:

[1] Market Flashes Yellow Caution Light: http://bigpicture.typepad.com/comments/2004/01/market_flashes_.html

[2] IJR: http://www.ishares.com/fund_info/detail.jhtml;jsessionid=J3DQQZAVOV0R0CQBB2BRB5QKAZSNQD50?symbol=IJR

[3] IJH: http://www.ishares.com/fund_info/detail.jhtml;jsessionid=J3DQQZAVOV0R0CQBB2BRB5QKAZSNQD50?symbol=IJH

[4] data: http://www.amgdata.com/

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