Investors are turning quite bearish on the stock market

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The stock market is falling after hours on new trade war news. In an environment like this, predicting the short term is extremely difficult. Trump talks about the U.S.-Mexico-Canada Agreement, stocks go up. Trump talks about slapping new tariffs on Mexcio, stocks go down. Today’s headlines:

  1. Investors are turning bearish on stocks very quickly.
  2. Diverging yield curves.
  3. Consumer Confidence is extremely high – just like 1999.
  4. In a falling interest rate environment, finance isn’t underperforming
  5. Copper is getting hammered.
  6. Dow’s breadth is weakening

Go here to understand our fundamentals-driven long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day.

Investors are turning bearish

AAII sentiment has turned bearish very quickly, considering that the stock market is not far away from an all-time high. Usually it takes a bigger decline for sentiment to turn bearish this quickly.

But this is understandable, given the current trade war environment. There’s a lot of short term uncertainty.

Politics and news aside, here’s what happens next to the S&P when AAII Bearish % is above 40%, AAII Bullish % is below 25%, and the S&P is within 10% of a 1 year high.

Diverging yield curves

You’ve probably heard about the flattening 10 year – 3 month yield curve by now. But while the 10 year – 3 month yield curve has been inverting even further, the 10 year – 2 year yield curve has not fallen. These 2 sections of the yield curve typically move together.

Is this normal? Here’s what happens next to the S&P when the 10 year – 3 month yield curve’s 5 month rate-of-change is negative for 14 days, while the 10 year – 2 year yield curve’s 5 month rate-of-change is positive.

Conference Board’s Consumer Confidence

The Conference Board breaks down Consumer Confidence into various categories, and all of these categories right now demonstrate that the market and economic expansion are late-cycle. For example, Future Expectations made a new high for this economic expansion.

Click here to download the data in Excel

Here’s what happens next to the S&P when Future Expectations exceeds 175.

All of the historical cases happened from 1999-2000. You can’t come to a conclusion based on a stat that’s essentially n=1. All we can say is that this is late-cycle.

Finance vs stocks

While the yield curve has been flattening, the XLF:S&P ratio (finance vs. broad stock market) has not fallen. This is surprising, because financial stocks often underperform when the yield curve pushes even deeper into inversion.

Here’s what happens next to the S&P when the XLF:S&P ratio goes up over the past 60 days, while the 10 year Treaury yield falls more than -0.3%

Not consistently bullish or bearish on any time frame.

However, this is mostly bearish for the XLF:S&P ratio, which suggests that XLF will soon underperform the S&P and the XLF:S&P ratio will “catch down” with the 10 year Treasury yield.

Copper

And lastly, copper has fallen 7 weeks in a row.

This is important right now, because copper and the stock market have a strong correlation.

Does this mark “exhaustion selling” in copper? Is this a short term bullish sign for copper and the S&P?

Not quite.

Dow breadth

The Dow McClellan Summation Index (breadth) is falling along with the stock market.

This marks the end of a long streak in which the Dow McClellan Summation Index has been above 600.

Here’s what happens next to the Dow (historically).

We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. Members can see our model’s latest trades here updated in real-time.

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
  2. Most of the medium term market studies (e.g. next 6-12 months) are bullish.
  3. The short term (e.g. next 1-3 months) is mostly mixed right now. The ongoing trade war certainly adds to this uncertainty. We focus on the medium-long term.
  4. Specifically, we can see that the 1-2 week forward market studies are slightly bearish, and the 1-3 month forward market studies are slightly bullish.

Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.

 

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