Can we avoid Dow 32000?

Stocks reached new record highs last week, right at the end of our lunar green period. That marks the first solid green period in quite a while and suggests that normal lunar cycles are coming back. I think we will see a pullback in the current red period, but probably not as deep as many traders expect.
Let’s have a look at the S&P 500 (click for larger image):

Last week’s high could mark an important top for the market. It depends how much of a downturn we see in the next week or two. If the pullback is mild then a push above 1900 is in the cards for the end of March. My technical indicators give a mixed message with the Earl2 showing no signs of peaking out yet. So there is further room to rise, but I think the overhead resistance levels around 1900 and 1940 will prove to be a tough barrier. April is likely to become interesting as it will be a month with eclipses. More on that in next week’s post

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With the month of February behind us I have updated the comparison chart with the 1920s. When I first posted this chart in June last year it looked like a very remote scenario. But the case for Dow 32000 has held up unexpectedly well. One of the main conditions to keep this scenario viable was for corrections to be very shallow. That has been the case in 2013. Now it remains to be seen if the Dow Industrials can push above 17000 later this year. That’s the second condition for this scenario to remain on the table.

Here is the updated comparison chart (click for larger image):

The correlation remains very high, and already started well before the bottom of the bear market. This correlation in itself is nothing remarkable, as it is always possible to find stretches of market action that look very similar. But what we have here is that the market circumstances were also very similar to the current ones. I have marked the major phases in the chart (1 to 4).
The 1920s started with a deflationary depression which was followed by a long period of ultra low interest rates with the Fed expanding its balance sheet. We have been going through the same playbook and have now arrived at the point that corresponds to August 1926. At that point the stock market started sputtering and in 1927 the US experienced a mild recession. In 1928 the Fed finally started raising rates. Instead of pushing the stock market down this marked the start of the blow-off phase with stocks almost doubling in the next 18 months. So much for “don’t fight the Fed”.

Could this happen again? I would rather ask: can it be avoided? If we continue along the same trail, then look for the economy to sputter in 2014 and that will keep interest rates near zero for the rest of the year. In 2015 the Fed will start tightening and that will cause stocks to break out to the upside. Why to the upside? Bonds inevitably go down when interest rates go up. This causes some money to flow out of bonds and into stocks (which look “safe” again in the eye of retail investors) and is a process that can start feeding on itself uncontrollably. At that point a disaster is inevitable.
In trying to avoid another great depression the Fed will then have managed to set the stage for one.

What would it take to write down this scenario? If the Dow drops below 14000 in 2014 then the odds would become very small.

Stay tuned,
Danny