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Monday, February 25, 2013 - 10:00
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Monday, February 25, 2013 - 10:00

Warning: Beware of the "March Effect" on the Stock Market

Monday, February 25, 2013 10:00 AM

"Beware the Ides of March." This famous line uttered by a soothsayer in William Shakespeare's 1601 play, "The Tragedy of Julius Caesar," warned the ruler of his pending demise on the 15th day of March.

Well, we all know what happened to Caesar.

We could apply this same warning to the stock market today.

In the past few years, every stock rally in the beginning of the each year was met by a sharp sell-off in the spring. Certainly, this doesn't portend to mean the entire year ended badly. In fact, those investors with the foresight to buy during the spring swoons generally ended the year with strong gains.

Based on the powerful rally seen so far this year, combined with the heavy resistance hit in the 14,000 area on the Dow Jones Industrial Average (DJIA), it appears that history is about to repeat itself in 2013 -- for the fourth year in a row.

Starting in late March 2010, a sharp bullish rally pushed the DJIA to a high of 11,258. The cash influx from the U.S. Federal Reserve had started to work its magic, sending shares solidly higher early in the year. Then an unexpected fear reemerged: Another European debt crisis. Concerns of a Greek default and debt contagion spreading across the euro zone and into the United States sent the stock market spiraling lower. The DJIA plunged more than 1,600 points within three months. Those with the foresight to buy during the correction or hold were rewarded handsomely as the DJIA closed sharply higher on the year.

The same pattern repeated in 2011 with a bullish optimistic start to the year. The DJIA soared all the way to 12,876 during the spring months. Next, fears of the U.S. "Fiscal Cliff" and debt ceiling began to permeate the market. The DJIA rapidly plunged more than 1,000 points before rocketing back to near the spring high. The market fears did not subside, sending the DJIA down again, this time more than 2,200 points. Once again, those with the fortitude and knowledge to buy during the lows did extremely well in 2011, despite the market closing near break-even for the year.

Stocks soared out of the gate early in 2012, pushing to a spring high of more than 13,300 in the DJIA. Powered by the Fed's low interest-rate stance and quantitative easing actions, it seemed like nothing could stop stocks from surging higher. Then once again, euro zone debt fears hit stocks like a ton of bricks in mid-April, sending the DJIA plunging more than 1,300 points by the middle of summer. Despite the sell-off of 2012, the stock market was up 16% for the year.

Expect the same scenario to repeat this year.

Stocks exploded higher at the start of the year, with the Fed using terms like "unlimited quantitative easing" and vowing to keep interest rates ultra-low for as long as possible. A temporary solution to the fiscal cliff problem also helped the market bullishness. The DJIA pushed its way to the 14,000 level, but has stalled out, as you can see in the chart above.

In fact, if you note on the chart, the 50-week simple moving average built a support zone each time the market sold off in the spring. If the same pattern repeats itself this year, then the DJIA should sell off around 1,800 points from the present levels to about 13,250 before the surge higher can resume.

Will this happen? Certainly no one knows for sure what the future holds. But if history is any guide, then we can expect a solid sell-off between now and May before stocks start climbing higher once again.

Risks to Consider: Market patterns do repeat, but never in the exact same way each time. While it appears the same pattern is setting up to repeat this year, no one really knows what will happen. Always position size properly and use stops when investing.

Action to Take --> The stock market has had a strong bullish bias this year so far. If you believe the recent cycle of the spring sell-off and rebound, then waiting for it to repeat prior to taking speculative long positions makes sense. If you are particularly aggressive, then shorting the DJIA now may be profitable if the cycle repeats itself.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.