Bulls Looking for a Cinderella Scenario

The complacent
and overly optimistic received a rude
wake up call last week. A wide swath of poor earnings surprised the market,
while Oil and geopolitics made traders all the more jumpier. I imagine investors
who have ignored the warning signs and cyclical patterns will be caught ill prepared
if a significant sell off were to begin in earnest.

Putting aside the doom and gloom for a moment, let us consider this question: What would need to occur for 2006 to be the strong market so many are expecting?

Forget the Goldilocks economy, we would need a Cinderella
scenario: One where nothing goes wrong, and nearly everything goes right. Earnings would have to stay robust; Energy prices would need to moderate; Inflation would have to go appreciably
lower; The Fed would need to end their rate tightening cycle; Consumer Spending could not falter – despite signs
of its tiring. Businesses would need to build on third-quarter Capex Spending, and would have to begin Hiring in earnest. All of the vulnerable Blue chip stocks would have to avoid major hiccups.

Those are just the macro economic issues. For Cinderella to get to the ball, none of the universe of negative "externalities" can come to pass. These include a major bird flu outbreak, protectionist legislation or other policy mistakes, an energy shock, a dollar crash, further geopolitical crisis over Iran’s nuclear ambitions, Chinese  decoupling of the Yuan, tax increases, or worsening deficits.   

 Those are just the foreseen issues, much less something currently not on the radar. Finally, equities would have to somehow avoid the regular corrections that were so common in all of the secular bear markets of the past.

Which brings us to the December Low Indicator: This technical signal has a good track record (which can be seen here) of
warning weakness. Anytime when the December closing lows have been breached in
the first quarter (on a closing basis), it has been an excellent warning sign
that markets are in for a correction later that year.

 Why bring this up today? The lowest actual closing price for the DJIA in December was 10,717.50 (12/30). Friday’s expiration mess closed 50 points below that, at 10,667.39.

The Stock Trader’s Almanac notes every prior December Low Indicator since 1952 (except one – 1996) has seen markets down at some point later that year.
The average drop is about 10.7%; it has been as small as 0.3% (1993), and as
large as 25% (1962, 2002).

This is another potentially confirming technical
indicator that the equity markets remain a volatile and dangerous place in
2006.