Stocks On The Brink Of A Sharp Correction? And Inflation Has Begun

In today's post I'm going to make the case for stocks moving down into a sharp correction over the next 4 weeks and conclude with my thoughts on inflation.

To begin we need to examine the last two intermediate cycles. Normally an intermediate cycle will run roughly 22 weeks. Well in our case the last two cycles were both stretched to 32 weeks by the Fed's QE3 programs. As you can see in the next chart both intermediate cycles had 4 smaller daily cycles embedded within them. This is pretty unusual as most intermediate cycles only have 2 or 3 daily cycles nested within. The market is now in desperate need of a short cycle to balance out these two long cycles.

Next let's examine the larger yearly cycle. As you can see out of the last 4 years, the larger yearly cycle bottom has occurred in the summer 3 times. The odds are favorable that the 2014 yearly cycle low should also occur in the middle of summer.

If the current intermediate cycle bottoms with the ongoing 2nd daily cycle, then we would get our yearly cycle low in early June. Right when it is expected.

On the other hand if somehow the Fed manages to stretch this intermediate cycle also, then the yearly cycle wouldn't arrive until the end of summer/early fall.

Obviously I don't give this scenario very favorable odds as I don't believe we will see three stretched intermediate cycles in a row, especially now that the Fed is withdrawing the fuel to generate another stretched cycle.

What appears to be happening is that stocks have entered a 4 month consolidation phase ever since the Fed started tapering.

A consolidation of that size is likely to produce a rather large move once the consolidation resolves one way or the other. I'm in the camp, based on my cyclical analysis that believes it will resolve downwards over the next 4-5 weeks. Go to that first chart again to see my expectations for what I think is about to play out.

THE INFLATION HAS BEGUN

Just like the topping process in 2007/08 the rotation of inflation out of the stock market and into the commodity markets has begun.

Notice that since the first taper in December the stock market has stagnated and gone basically nowhere for the last 4 months. During that period inflation has begun to leak into the commodity markets. This is the same process that occurred as stocks topped in 2007/08.

We should see a mild deflationary period over the next 4-8 weeks and all assets should take a hit. But once that correction has run its course stocks should continue the stagnation phase as the cyclical bull continues what I expect will be a multi-month topping process. As this progresses the inflation that has been stored in the stock market will leak faster and faster into the commodity markets during the second half of the year.

More in the weekend report.