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Stocks need to know: Where are we in the tightening cycle?

Are we at the start of a tightening cycle, or not? That seems to be the question.

The answer: We seem to be in that shadowy period leading up to a tightening cycle.

That's an important distinction for stocks, because equities tend to gain in the period leading into those cycles, then reverse when the tightening begins.

MKM Partners, for example, noted that in the six months leading up to the three prior tightening cycles—February 1994, June 1999 and June 2004—the S&P 500 gained an average of 6.3 percent, led by financials, which were up 12.2 percent. That makes sense, since interest rates invariably rise, helping banks.

But three months after tightening began, the S&P 500 was lower in all three periods by an average of 4.2 percent. Defensive stocks such as telecoms outperformed cyclicals, including industrials and consumer discretionary.

The markets seem to be unsure what period we are in. After a huge rally yesterday in stocks, the euro, and bonds, much of that is being unwound today. The dollar and oil in particular have reversed. Brent crude is down almost three percent after being up about five percent yesterday.

If we look at the fundamental picture, here is what the Federal Reserve sees: lower growth, lower unemployment, low inflation, and a slower increase in interest rates. This would seem to favor cyclicals like retail and home builders.

A big issue is we don't know if the dollar is going to stabilize or not. My bet is the rally isn't over. However, even if it moderates that could benefit U.S. companies with high foreign sales exposure, like Yahoo, Molson Coors, SanDisk, or even Pfizer.

Get the confusion? Fundamentals may favor certain sectors, but the prospect of rate hikes make any predictions fairly short-term.

That's why it's a difficult period for stocks. Still, you can't argue with the current state of global markets:

  • China: Seven-year high
  • Germany: Historic high
  • Russell 2000: Historic high
  • S&P 500: 0.8 percent from historic high
  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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