The regular readers of this newsletter will know that I have been bullish on the markets for some time, but that is changing. The S&P 500 reached an all time intra-day high on April 10th, but the rally may not last long and could possibly top out at the end of April or the beginning of May, as it has done in the last two years.

We are in the process of completing a three-peat – a strong market in the first four months of the year with the defensive sectors outperforming the cyclical sectors, for a third year in a row. We all know what happened in the last two summers. It has been interesting to note how many commentators have been on TV talking about how the defensive sectors have been outperforming the cyclicals and that this is bearish for the markets. I have discussed this phenomenon over the last three years, in the beginning part of each year. There is no question that it general, when the defensive sectors outperform, the market is becoming more conservative. This is true at any time of the year.

Seasonal analysis not only provides insight into the sectors of the market that are poised to outperform, but it also provides valuable information on the health of the market. When sectors of the market do not perform as expected, by following their seasonal trends, astute seasonal investors can use the information to determine if the market is poised for a rally, or setting up for a correction. In my April market video I discuss the phenomenon of the defensive sectors outperforming at the beginning of the year and state that is a concern and indicates a possible market correction, but we cannot tell if the correction is going to be next week or in the near future. In other words, defensive sector outperformance cannot be used as a timing indicator to make a portfolio decision. Nevertheless, it is valuable in raising concern to possible unfolding events.

Over the last two years and this year, at the beginning of the year, the defensive sectors have outperformed when the cyclical sectors typically outperform. So what is the big deal? The market is telling investors that the big money is “scared” as it is seeking safety at a time of the year when it would typically be chasing beta. The market cannot proceed higher over the long-term on the back of the defensive sectors alone. One of two events must happen: either a rotation out of the defensive sectors into the cyclical sectors must take place, which will keep the market moving higher, or the market must correct.

So what should we expect? How do the seasonal trends help us at this point? Currently, the cyclicals have had a couple of days of strong performance, outperforming the defensive sectors. This is very typical in the month of April (see the Thackray Sector Thermometer, Thackray’s 2013 Investor’s Guide, page 42). It is very possible that we will see a continuation of this trend in the next couple of weeks, which would not be out of the ordinary. If the defensive sectors gain control once again at this time, it would be indicating that a correction is close at hand. If the cyclicals continue to outperform, it would be a signal that the market still has a bit of life left and might rally into May.

Should we expect a massive rotation from the defensive sectors to the cyclical sectors over the next few months – NO. Although anything is possible, the seasonal trends do not support a sustained rotation into the cyclical sectors past the first week in May. In fact, if the cyclicals do outperform in the next few weeks, when they start to roll over, it will probably be a sign that the market is setting up for a correction. Investors beware.