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Clif Droke

Clif Droke

Clif Droke is the editor of the two times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock…

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Forecast for 2005

As discussed in my previous broad market commentary in December, the broad market has topped in the short-term and is being pressured under the force of the dominant short-term cycle which is scheduled to bottom later this month. More importantly, the fateful "First Five Days" of 2005 are over, and based on this historically accurate indicator we'll have a tricky year ahead. The old saying is, "As go the first five days, so goes January, so goes the year." The month isn't over yet, of course, but already it looks like we could have a surprise ahead for the bulls who are expecting a super positive 2005 based on the "Year Five Phenomenon."

The correction that technically began in December is still underway and should carry the major indices lower before the expected short-term cycle bottom later this month. Based on my latest analysis the NASDAQ should bear the brunt of the decline, with the Dow 30 being least affected.

The S&P 500 index (SPX) daily chart shows that parabolic arc that peaked in December and has pressured the index since the New Year began. The SPX peaked to the right-of-center of the "vertex," or mid-point, of the parabolic dome. This suggests that the correction now underway isn't the terminal high for the SPX and that once the short-term cycle bottoms the SPX will continue along its upward path to revisit its previous high and most likely to a higher high. The uptrend line currently intersects at approximately 1130-1140.

At this point I'm going to give my forecast for 2005. I noted last year that 2004 would likely be a "difficult" year at times due to the 10-year cycle bottoming. Year 2005 won't be "difficult" per se, yet I believe it will be tricky.

Year 2004 saw the lowest market volatility at any time since 1994! I predict that this will change in 2005 with the return of volatility. We've all heard how the fifth year of the decade always produces a gain for the year, an argument the bulls have hanged their hats on for 2005. From the other side of the fence, we've heard the bears tell how the year following a presidential election tends to be a "house cleaning year" and thus a downer. Which side will be correct for 2005 -- the bulls or the bears? I believe both sides will be correct!

How is this possible, you ask? Here's how: On an intra-yearly basis I believe the broad market will make a higher high compared to 2003-2004 in all three major indices. However, on a year-end basis I suspect we could actually have a down year. If this materializes this would actually be the first time in 120 years the "fifth year phenomenon" has failed! Of course, we'll have a much better idea by the second half of the year as to whether or not we're heading for a downer for 2005. Investor psychology will be one major guide post.

Speaking of market sentiment, I wouldn't be surprised to see the percentage of bullish investors as measured by both Investor's Intelligence and AAII hit as high as 75% by the second quarter of this year. If this happens it will put an interim top on the market and would virtually assure a rough second half of the year by comparison. Why would I think that the second half of 2005 would be rough (particularly the fourth quarter) when the X-5 year is always bullish? Because unlike any other time in the last 120 years we have a longer-term configuration in the cycles unlike any other time.

For instance, last year I kept pounding on the 10-year cycle and noted that once it bottomed in the fall of the year it would produce a magnificent rally in the stock market that would carry the indices into 2005 on a bullish note. This much transpired. However, what I failed to consider is that when the 10-year cycle bottomed, the 20-year cycle also peaked. Since the 30-year cycle peaked in 1999/2000, the last of the super long-term cycles have all peaked now as we head for the fateful 2010-2014 time frame when the economic K-wave and the 120-year cycle are both due to bottom.

Does this mean the magnificent rally off the 2004 lows has ended? No, it doesn't. I still think the S&P 500 will head toward the 1260 area and I expect to see the Dow 30 index over 11,000 by the end of the first quarter of 2005. After this I expect a topping process lasting into the spring and then the dominant interim is due to bottom around mid-year. This would obviously produce another sharp decline in the broad market around this time. This in turn will probably be followed by a summer rally but to either a lower high or to a double top. Then for the corker...we could very well have an "October Massacre."

Two things typically conspire to create October crashes. One of them is excessive valuations and excessively bullish investor sentiment bordering on giddiness. If the S&P reaches for my 1260 area target this year it would obviously create even more bullishness on top of the already high levels of investor sentiment. Hence my forecast for the bullish consensus to reach 70-75%. Another consideration for 2005 is the 6-year cycle which is due to peak around September/October. This same exact configuration was what caused the crash of 1987, viz., the peaking of the 6-year cycle along with excessive bullish sentiment among investors. Keep this in mind as we approach the late summer/early fall.

Assuming the market takes a dive this fall, I'd expect it to be followed by a bottoming process lasting until the end of the year. The more severe the hit, the longer the bottoming process. So you can see how this could all play out to be a down year for 2005 as measured from start to finish. The first half of the year will largely be owned by the bulls, while the second half looks like it could be controlled by the bears. Thus, both sides of the fence will likely have their fair share of control and conquest in 2005.

What about the energy outlook for 2005? In last year's forecast I predicted that the price of coal and other base minerals would enjoy a meteoric bull market and have a very good 2004, a forecast that materialized. I neglected to mention crude oil in last year's forecast and obviously oil was a big winner in 2004. How will oil likely perform in 2005? I expect the first half of the year to be largely a period of consolidation for the crude price, followed by an upward move in the second half of the year. I expect crude to re-test the $55 area top from 2004 sometime in the latter half of 2005.

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