More signs of macro slowdown, and what this means for stocks

by 

Throughout this extremely persistent rally, the stock market keeps ramping higher in the final hour of each trading day. While some bearish traders see this as a sign of government “manipulation”, it probably doesn’t mean anything of substance. 99% of conspiracy theories turn out to be false.

Go here to understand our fundamentals-driven long term outlook.

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.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Philly Fed

A bevy of economic data caught the market’s attention today. The media networks are attributing today’s stock market decline to “weak economic data”. For example, the Philly Fed’s Business Outlook Index fell below zero for the first time since 2016.

It’s important to note how noisy this indicator is. E.g. in the 1990s, it was very common for this indicator to fall below zero.

Is this bearish for stocks?

Here’s what happens next to the S&P when the Philly Fed Business Outlook Index falls below zero, for the first time in 2.5 years

As you can see, this is more bullish than bearish for stocks 6-12 months later, with the big exception of the 1973-1974 bear market.

Initial Claims

We continue to monitor Initial Claims because

  1. It is one of the best leading indicators for the stock market.
  2. It is very low right now.

Initial Claims’ 4 week moving average keeps creeping up, while the Unemployment Rate is also creeping up right now.

Here’s what happens next to the S&P when Initial Claims’ 4 week moving average rises more than 13% over the past 20 weeks, while the Unemploymnt Rate is above its 12 month moving average.

As you can see, this is quite bearish for stocks 6-9 months later. The recent rise in Initial Claims and Unemployment may be attributed to the government shutdown.

Hence, I would consider this to be a long term warning sign for stocks instead of a long term bearish sign. Bulls should watch out if this persists.

Conference Board LEI

The Conference Board’s Leading Economic Index has gone 4 months without making a new high.

This is not worrisome on its own. But combined with other signs of macro slowdown, it is a problem.

Here’s what happens next to the S&P when the Conference Board LEI goes 4 months without making a new high, while Unemployment is above its 12 month moving average.

As you can see, the stock market’s forward returns are less bullish than random.

Another warning sign, but not a long term bearish sign. Watch out if this persists another few months.

Dow up 9

With 1 day left this week, the Dow could be on the verge of being up 9 weeks in a row.

If the Dow obtains a 9 week win streak, then it’s 1-2 week forward returns will lean bearish.

S&P 500 momentum

The stock market’s short term momentum is very strong, with the S&P’s 5 day RSI above 50 for 33 consecutive days.

On its own, this is not consistently bullish or bearish for stocks.

But when you only examine the late-cycle cases (Unemployment is under 6%), then you can see that the stock market’s 3-12 month forward returns are slightly more bearish than random.

Small caps breakout

The Russell 2000 index (small cap stocks) is on the verge of breaking out out above its 200 day moving average, after being deeply oversold. The Russell 2000 index crashed the most in Q4 2018.

Here’s what happens next to the S&P after the Russell closes above its 200 day moving average, while being deeply oversold sometime within the past 3 months.

The sample size is small, but this is more bullish than bearish for stocks 2-12 months later.

Here’s what happens next to the Russell 2000

Once again, the sample size is small, but this is more bullish than bearish for stocks 2-12 months later.

Oil

It’s encouraging to see oil rally along with the stock market.

Over the past 39 days (since the December 24, 2018 low), the S&P has rallied more than 15% while oil has gone up more than 30%. In other words, stocks and oil crashed together in Q4 2018, and are now rallying together.

From 1983 – present, there is only 1 other historical case in which stocks and oil rallied so much together:

April – June 2009, at the start of the current bull market

Let’s relax the study’s parameters

Here’s what happens next to the S&P when it goes up more than 10% over the past 39 days, while oil goes up more than 25%

This is more bullish than bearish for stocks on every time frame.

Here’s what happens next to oil.

Once again, more bullish than bearish for oil on every time frame.

Click here for yesterday’s market study

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimstic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (i.e. next 6 months) is mostly neutral. There are a few more medium term bullish studies than medium term bearish studies
  3. 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.