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Stock market had a rough January, what's next?

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On December 31st, the U.S. stock markets closed what was a truly fabulous year. The Dow made an intraday high of 16,611 and closed at 16,576. The party continued with a new intraday high of 16,629 on January 7th.

I kicked off the year with a column suggesting 2013 was a "fake out" year where investors were lulled into complacency by chasing risk. Looking at the words of the year shed light on what people were thinking about. Merriam Webster's word of the year was "science" and the Oxford dictionary's was "selfie". Just a year earlier the popular words were "socialism", "capitalism", "bigot", and "schadenfreude".

A couple of weeks ago, I suggested that investors had a hard time identifying bubbles. I should have said investors always have a hard time identifying bubbles. It is simply the human condition. What makes this one more pernicious is that it comes not too long after the partial bubble popping of 2007-2009. I use the word partial since action taken by the Fed and government prevented the bubble from fulling popping. Not only did they prevent it, but they have lured investors into riskier behavior with their inflating efforts. The end of this bubble will engender more frustration.

On January 13th one of my proprietary indicators suggested the market was due for a correction on a short-term basis. The term correction in this context implies a fall in the hundreds of points. If the bear market rally pattern since 2009 is to continue, the correction should be short in duration (2-4 weeks). There is another indicator I follow that looks at the intermediate term. That indicator has not demonstrated any corrective action since the summer of 2011 during which time, it certainly appeared as if the bear market rally from 2009 had ended. The intermediate indicator has not flashed correction, yet, but this week's action could very well turn it bearish The final indicator I use is for long-term movement. This indicator did not register a bear move in the summer of 2011 like the intermediate term. The last significant bearish signal received in my long-term indicator was in February of 2008, which of course led to a market decline in the thousands of points. There is a specific level I am looking at with the long-term indicator that will synch with the short-term and intermediate term indicators, making this last top one of historical significance.

With many sentiment indicators demonstrating extreme bullishness, the proprietary indicators noted earlier acquire greater significance. The foundation is set for the continuation of what we experienced from 2007-2009. Though we have a foundation, the bear remains a bit distant for now. Whether the bear redevelops or the bull struggles for a final run, there are powerful trends at work in the markets and the economy. I have developed two reports, one for small businesses and one for investors, highlighting the dominant trends for 2014 and the effect on each interest group. They are available at The Sentinel.

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