Stocks Likely to Top Out This Spring

03/04/2013 10:30 am EST

Focus: MARKETS

Keith Richards

Portfolio Manager, ValueTrend Wealth Management and Worldsource Securities Inc.

The bear may be ready to come out of hibernation, says Keith Richards of Investor’s Digest of Canada.

Since 2012, I’ve been predicting bullish markets for the first half of 2013, but bearish markets thereafter. In essence, I think stocks will hit a top by this spring before reordering themselves into a normal cyclical bear market.

Now at just over 1,550 for the S&P 500, this technical resistance level will lower a ceiling that will be very hard to break through without the backing of strong economic data.

Over the past 12 years, US markets twice failed to break through technical resistance. And on both occasions—September 2000 and October 2007—the markets failed. And both these failures ushered in big bear markets. Moreover, economic data leading into 2000 and 2007 was robust, leaving me wondering how stocks might permanently break through the 1,550 level this time around.

Then there’s the matter of seasonal patterns. They’ve shown that markets often outperform until late April, only to underperform from May until November. And with April drawing steadily closer, we’re likely due for a period of underperformance.

Yet another reason for my prediction is the US presidential cycle. In any presidential term, stock performance in the first year—in our case, 2013—is on average the worst, with bear markets usually bottoming out in the second year.

You can also find support for my prediction by looking at prices for those commodities that are very sensitive to swings in the economy. For example, some key commodities, such as copper and oil, are now well below their two-year highs, despite the S&P 500 itself having made new highs. This shows the potential for internal deterioration of the economy in the US, Canada, and other consuming nations.

Meanwhile, many studies of market sentiment indicate excess optimism. And for contrarians, excess optimism is always a sell signal.

Then, there’s the S&P 500 VIX. This index, which measures options traders’ expectations for volatility, recently hit levels not seen since 2007. This suggests investors are complacent—that is, they see little risk over the coming months.

In the meantime, a bearish technical pattern known as a wedge—often, an ominous sign—may be forming on the S&P 500. One last indicator is the Shiller price-to-earnings ratio. Developed by Robert Shiller, an economics professor at Yale University, this P/E is close to its typical sell level.

Of course, I could be wrong about the potential for a bear market over the next 12 months or so. Stocks could always break out of their historic cycles and permanently take out the 12-year highs, giving us a new era of bull-market returns that seemingly go on forever.

Yet even if you reject the notion that the bear will emerge from hibernation later this year, you should certainly accept the very real probability that the four-year bull will find itself penned up. Indeed, the last two corrections—in mid-2010 and mid-2011—suggest that before the bull continues, such a retracement would spark a double-digit loss.

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