Since my model top of 22 Feb, stock indices have either begun a pullback or are digesting gains ahead of an imminent further leg up. My models predict a pullback into 9 March, so the former is my primary expectation. Supportive of a pullback here are a perfected DeMark sell set-up on the Dax, a potential Vix bottom in relation to US stocks and a historic extreme in the CS Fear Index (which suggests participants are insuring against perceived forthcoming downside):

Source both: Andrew Nyquist

Source: Bloomberg

If we do see a pullback this week and next, then recall Tom De Mark suggested it may be a correction that frustrates bears – lots of back and forth and overall shallow, before pushing on again.

Chris Ciovacco points to a 2004 rhyme and suggests the stock market needs to flatten out at the top following such a powerful up trend, before any significant correction:

And this fits with not having seen divergence in market breadth yet, which would normally signify an important topping process.

So if we picture something between shallow consolidation and shallow gains in the weeks ahead for stocks, then that sets the scene for commodities to outperform, and that’s what we’ve been seeing the last few sessions. Crude oil looks set to challenge its 2011 high of around $114. Gold and silver are at key levels, whereby a break above would likely attract significant money flows.

But if we consider the fortunes of pro-risk as a whole, a fly in the ointment remains ECRI, who reiterated their recession call (for sometime in 2012) on Friday, despite improvement across the board in leading indicators from Conference Board’s own to Money Supply to Financial Conditions Index to the stock market itself. I note they quoted flatlining GDP and retail sales in their defence (yet both these show recent improvement trends) and marginally improved WLI (which has actually risen from -10 to -3.5), so that makes me a little skeptical. Well, I don’t want to disregard them because of their track record, and Chris Puplava suggests it’s all compatible: that we have a growth window into mid-2012 before ECRI’s call comes good. He points to prices paid as a lead indicator for manufacturing, which shows that summer 2012 rollover:

Source: PFS Group

I would summarise like this: if the economy is to roll over by mid-year we will see various leading indicators roll over ahead of that, and not be reliant on the word of ECRI. Right now, we see leading indicators improving, and where I identified potential early casualties in the form of earnings and economic surprises (both at historic highs) we still don’t yet see a decisive tipping over. I maintain the expectation of a growthflationary finale into the secular peak, with the emphasis on inflation. So let’s see how things progress.

Looking at the S&P500 on short term view with updated actual and forecast geomagnetism, this is what we see:

We saw a cycle inversion or very shallow pullback around 7/8 Feb, and now the next target is around 22 Feb for a potential medium term top, subject to seeing a set of overbought and overbullish indicators. Indicators have been able to cool a little in the last few sessions with some digestion of gains, suggesting we can push higher before reaching adequate extremes.

We can also see from the above chart that, based on forecasted geomagnetism, the trend is still up into mid-March. The threat to this is actual geomagnetism being greater than forecast, and at the time of writing an unforecasted geomagnetic storm is in progress. Below is a reminder of the historic seasonality of geomagnetism and its correlation with stock market seasonality, and it’s important to note that this is an average. In February 2012 so far we have not seen much of a pick up yet in geomagnetism, compared to seasonal history, but the threat is there that it begins to increase, putting pressure on the market, and as we move towards March, the threat becomes greater.

Therefore, I will be looking to see if pro-risk can push on into around 22 February whilst making a divergence with the model and hitting overbought/overbullish indicator readings, or whether we postpone an intermediate top until mid-March, if actual geomagnetism stays relatively low and we don’t hit screaming top signals in late Feb. If we do keep pushing on into mid-March, I note the first major Bradley turn of the year is 16th March, plus Greece’s debt payment deadline is 20 March, if that saga drags on unresolved. So let’s turn to macro fundamentals.

Credit markets continue to improve. The rise in Portugese CDSs in early 2012 has now been reversed, and PIIGS CDSs as a whole and Japanese CDSs remain contained. The US earnings beat rate has crept up to over 60% as the season has progressed, so fairly middling compared to previous seasons and not a particular reason to be bearish. ECRI US  leading indicators continue to accelerate upwards (whilst still negative) and the latest OECD leading indicators show a tick up for the OECD area as a whole:

Source: OECD

Other than the US, the countries contributing to the general uptick include Japan, Russia and India.

Economic Surprises for the major economies and for the US continue to oscillate around a historic topping area. Until we begin to see a downtrend, pro-risk sentiment should be sustained, but a downtrend is likely to be close, due to this being a mean reversion indicator (data starts to disappoint versus ratcheted up estimates).

Source: Bloomberg   

Here is a reminder of the market’s overall sideways action once Economic Surprises topped out and began to fall away gradually in 2009-10, following a similar surge up from an extreme low (that was a leading indicator for a market rally).

Recall that history suggests overall sideways action in the next 18 months for equities, with a slight upward bias, whilst commodities outperform (based on the last 3 secular commodities conclusions into their associated solar peaks).

Lastly, some analysts are pointing to the Vix as a reason to expect a market reversal, as it back at the level which has marked a low multiple times in the last 3 years. However, as the chart shows below, the Vix could move sideways whilst stocks push higher, for a period.

Source: Bloomberg

Not only that, but if we look further back to 2005-2007, the final part of the last cyclical stocks bull, the Vix oscillated in a lower range (10-15 rather than 15-20) than in the last couple of years, which at least gives the possibility that the Vix could drop beneath the apparent horizontal base shown above.