The S&P 500 is still hovering at its 2800 resistance. Meanwhile, the NASDAQ is up 10 weeks in a row while the S&P is up 9 of the past 10 weeks. The bears are looking to short here, but they do not have momentum on their side.
The economy’s fundamentals determine the stock market’s medium-long term outlook. Technicals determine the stock market’s short-medium term outlook. Here’s why:
- The stock market’s long term risk:reward is no longer bullish.
- The medium term direction (e.g. next 6-9 months) is more bullish than bearish.
- The stock market’s short term has a slight bearish lean.
We focus on the long term and the medium term.
While the bull market could keep going on, the long term risk:reward no longer favors bulls. Towards the end of a bull market, risk:reward is more important than the stock market’s most probable long term direction.
Some leading indicators are showing signs of deterioration. The usual chain of events looks like this:
- Housing – the earliest leading indicators – starts to deteriorate. This has occurred already
- The labor market starts to deteriorate. Meanwhile, the U.S. stock market is in a long term topping process. We are in the early stages of this process, but the deterioration is not significant.
- Other economic indicators start to deteriorate. The bull market is definitely over, and a recession has started. A U.S. recession is not imminent right now
Let’s look at the data besides our Macro Index
The latest reading for Housing Starts fell from its previous reading (1214k to 1078k). The key point is that Housing Starts has begun to trend downwards.
Historically, Housing Starts trended downwards before bear markets and recessions began.
Since the recent downtrend in Housing Starts is not yet significant, we treat this as a warning sign instead of a long term bearish sign. Building Permits isn’t entirely confirming the weakness in Housing Starts.
Initial Claims and Continued Claims are trending sideways. Historically, these 2 leading indicators trended upwards before bear markets and recessions began. This is something that bulls should watch out for IF Initial Claims and Continued Claims trend upwards significantly over the next few months.
The Delinquency Rate on All Loans is trending down. In the past, the Delinquency Rate trended higher before bear markets and recessions began.
The year-over-year change in Inflation-adjusted personal consumption expenditures is trending sideways.
Historically, this data series trended downwards in the beginning of a bear market & economic recession.
Inflation-adjusted corporate profits are trending higher. This is important because stock prices and corporate earnings move in the same direction in the long run.
Real GDP growth has increased 10 quarters in a row. This is a record streak from 1948 – present.
This is something that bulls should watch out for. When a 5+ quarter streak of consecutive real GDP growth ends, the stock market’s forward returns are more bearish than random.
This study has yet to be triggered, but watch out in 2019 if real GDP growth starts to deteriorate.
Along with GDP growth, earnings growth could turn negative for Q1 2019.
If this happens, it will be more of a long term bearish sign.
Here’s what happens next to the S&P when earnings growth turns negative.
The sample size is small, but this is more of a bearish sign for stocks 6-12 months later. There are some false bearish signals here of course (1998 and 2012), so take this with a grain of salt.
Conclusion: The stock market’s biggest long term problem right now is that as the economy reaches “as good as it gets” and stops improving, the long term risk is to the downside.
Economic deterioration is not significant yet, so the “bull market is over” case is not clear right now. We’re in a “wait and see the new data” mode. As long as the economic data doesn’t deteriorate significantly, the bull market case is still valid.
*For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.
Macro has deteriorated a little, but the deterioration is not significant enough to warrant a full blown recession and bear market. Absent significant macro deterioration, this is a good sign for stocks in 2019.
The S&P has gone up 9 of the past 10 weeks. In other words, strong momentum.
Historically, such strong momentum has been a bullish factor for stocks 1 year later.
The S&P’s 10 week rate-of-change has gone from less than -10% to more than +15%. These V-shaped recoveries are usually bullish for stocks 6-12 months later.
The S&P’s breakout above its 200 day moving average has been sustained.
Here’s what happens next to the S&P when it closes above its 200 dma for 13 consecutive days, after being more than -10% below its 200 dma sometime in the past 3 months.
This is consistently bullish for stocks 9-12 months later.
The NASDAQ has been even stronger than the S&P. It has gone up 10 of the past 10 weeks.
Historically, this has been quite bullish for the NASDAQ 2-3 months later.
A big concern that financial media often cited in 2018 was the NASDAQ’s poor breadth. The NASDAQ’s rally in 2018 was almost entirely generated by Netflix and Amazon’s meteoric rally. This had some market watchers thinking that the stock market would crash if Netflix and Amazon stopped rallying.
This is no longer a concern in 2019. The equal-weighted NASDAQ has outperformed the market-cap weighted NASDAQ for 5 consecutive months. In other words, the NASDAQ’s gains are broadly shared, and not just driven up by a few big tech companies.
Historically, this has been bullish for the NASDAQ.
Correlations & sectors
Oil has rallied significantly along with the S&P 500.
Here’s what happens next to the S&P when oil goes up more than 20% over the past 2 months while the S&P goes up more than 10%.
*Data from 1983-present
Cyclical stocks have significantly outperformed defensive stocks over the past 2 months. XLI (industrials sector ETF) has gone up more than 15% from January-February while XLU went up less than 10%
From 1998 – present, this has been mostly bullish for stocks 6-12 months later.
Over the past 2 months, copper has gone up more than 10% while the S&P has gone up more than 18%.
Here’s what happens next to the S&P when copper goes up more than 10% over the past 2 months, while the S&P goes up more than 15%.
*Data from 1971 – present
This is quite bullish for the stock market 6-12 months later.
The stock market’s strong rally has been accompanied by falling volume. Traditional technical analysis states that “rallies accompanied by falling volume” are bearish.
Here’s what happens next to the S&P when $SPY (S&P 500 ETF) rallies more than 10% over the past 10 weeks, while SPY’s volume falls more than -50%
This is a short term bearish sign for stocks over the next 1 month.
As of Monday, the Put/Call ratio’s 10 day moving average is now -13% below its 200 day moving average. This demonstrates some short term complacency in the stock market.
Historically, this was a short term bearish sign for the S&P over the next 2 weeks.
Breadth is extremely strong.
The NASDAQ McClellan Summation Index is now at 777. From 1998 – present, this has only happened 2 other times.
The NYSE McClellan Summation Index currently exceeds 1280.
From 1998 – present, such strong breadth readings have been bullish for stocks, especially 1 year later.
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 more bullish than bearish.
- The stock market’s short term has a bearish lean due to the large probability of a pullback/retest. Focus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.
Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.
Our discretionary outlook does not reflect how we trade the markets right now. We trade based on our quantitative trading models. When our discretionary outlook conflicts with our models, we always follow our models.