The S&P is up 14 of the past 18 weeks. The NASDAQ is up 16 of the past 18 weeks. There is a sense of FOMO in the air. Meanwhile, real GDP growth remains solid, which directly flies in the face of the “economy is terrible” narrative.
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Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.
The stock market’s momentum is extremely strong. For example, the NASDAQ is up 16 of the past 18 weeks.
From 1971-present, this has only happened 4 other times.
Here’s a closeup look at these 4 cases.
This is February 2000. A bear market and recession ensued within the next year.
This is July 1989. A big correction + economic recession ensued 1 year later.
This is August 1980. A big correction + economic recession ensued 1 year later.
This is March 1972 for the S&P 500 (StockCharts has limited NASDAQ data pre-1978). A bear market + economic recession ensued more than 9 months later.
The sample size is small, but this does appear to be a blowoff top of sorts. The “bull market has 1 year left” scenario represents the most optimistic case in my mind.
While the NASDAQ is up 16 of the past 18 weeks, the S&P is up 14 of the past 18 weeks.
As you can see in the following table, this is mostly bullish 6-12 months later.
You know the narrative. The economy is slowing down, economic data is constantly missing expectations, global recession fears, etc.
But remember: focus on the data and ignore the narratives. Most of the narratives are wrong (e.g. some renown “financial experts” are scratching their heads as to why the Citigroup Economic Surprise Index is crashing but stocks aren’t. A simple Google search would have explained to them why their narrative is wrong.)
Here’s the latest real GDP data. Real GDP growth is increasing, which is markedly different from prior recessions. GDP growth trend downwards before historical recessions.
Real GDP growth has been above its 10 year average for 11 consecutive quarters, which is a very long time of sustained economic growth. This has only happened 4 other times in the past.
GDP is not my favorite economic indicator, but it does illustrate that there is no significant deterioration in the macro economy. The stock market and economy move in the same direction in the long run.
Is this normal?
The following tweet caught my eye recently:
We’ve already looked at why “global and domestic economic data worse since 09” is wrong. (And I never understood why being snarky is considered “a healthy thing” or popular on Twitter). But the author does have a point about “50 of 77 trading days closed positive since January 1” being abnormal.
The S&P has gone up approximately on 2/3 of days since the stock market’s rally began in late-December 2018. The random probability of the stock market going up on any given day is 56%.
Here’s what happens next to the S&P when it goes up at least 54 of the past 84 days.
Mostly bullish 6-12 months later. Momentum is a well researched factor based on the premise “objects that are in motion tend to stay in motion”.
While the S&P went higher this week, VIX also went higher.
How normal is this?
Here’s what happens next to the S&P when it goes up more than 5% this week while the S&P goes up more than 1%.
Happens quite often, and isn’t consistently bullish or bearish.
Here’s what happens next to VIX.
You can see that VIX tends to keep falling. I know that it’s very tempting to go long VIX. I’ve thought about doing so myself. But the problem is that VIX can stay “low” longer than your VIX ETFs can stay solvent. VIX ETFs face terrible ETF decay even when VIX is flat.
The widely watched 10 year – 2 year yield curve closed above its 200 day moving average today for the first time since 2017.
As I’ve said in the past, a yield curve inversion isn’t as bad as a yield curve steepening. A significantly steepening yield curve is how prior bear markets and recessions started.
Here’s what happens next to the S&P when the 10 year – 2 year yield curve closes above its 200 dma for the first time in 1 year.
So why isn’t this bearish?
Because the yield curve tends to flatten out at the bottom, bouncing back and forth around its 200 dma before steepening significantly. This is merely the first bounce around the yield curve’s 200 dma.
Here’s what happens next to the yield curve itself.
You can see that the yield usually keeps flattening.
*When the yield curve falls “-900%”, it means that it went from +0.02% to -0.18%
A few days ago we mentioned that the NASDAQ’s McClellan Oscillator would soon make a death cross, which in the past was short term bearish for the NASDAQ.
The NYSE McClellan Oscillator has also made a death cross.
The S&P’s 2 week forward returns aren’t as bad as the NASDAQ’s 2 week forward returns, but its 2-3 month forward returns are less bullish than random.
One more thing…
The stock market has been grinding higher incessantly. Traders tend to have itchy finger syndrome where they want to catch each and every -3% pullback. More often than not, they sell and watch the market rally another +4% before falling -3%.
To quote Reminisces of a Stock Operator
The real money is made by being right and sitting tight.
The short term swings are very tempting. But the real money is in the trend.
Here is our discretionary market outlook:
- The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimistic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
- The medium term direction (e.g. next 6-9 months) is mostly mixed, although there is a bullish lean.
- We don’t predict the short term because the short term is always extremely random, no matter how much conviction you think you have. Focus on the medium-long term.
Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.