by Troy
It seems like it was only yesterday when the U.S. stock market was crashing -20%. Today, the S&P is almost within 2% of its all-time high. This has been an extremely sharp reversal.
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.
Sharp reversal
The stock market has made a very sharp reversal, surging out of “bear market territory” (the traditional -20% definition) and almost within 2% of all-time highs in less than 4 months.
From 1950 – present, such sharp and quick reversals have been quite bullish for stocks 3-12 months later.
But what if we include pre-1950 data? A little less bullish 3-12 months later.
The reason we don’t usually include pre-1950 data is that pre-1950 data is flawed. The S&P 500 does not include dividends reinvested, and dividend yields pre-1950 were much higher than dividend yields post-1950. E.g. on the surface it looks like the S&P fell -1.07% 9 months after July 18, 1947 (see above chart). But when you factor in the dividends, the S&P was actually up during those 9 months.
Seasonality
The Dow’s seasonality in April has been consistently bullish over the past 13 years.
But what about pre-2006?
Not quite as bullish.
It’s only because of the post-2005 streak that April is the stock market’s best month in terms of seasonality.
You can see why we consider seasonality factors to be of tertiary importance. Seasonality streaks can appear from out of nowhere, and can also disappear when you least expect it to.
Macro: retail sales
Here is another point for macro weakness. Retail Sales is no longer improving.
The longer this lasts, the more this becomes a problem. Here’s Retail Sales’ 6 month rate-of-change.
As you can see, this figure has been negative for 3 consecutive times. From 1992 – present (when data began), the only other time this happened was in 2008.
Does this mean that 2019 is 2008 “all over again”?
No.
While this certainly isn’t good for stocks, Retail Sales is not the best figure for gauging the macro state of the U.S. economy. What’s popular isn’t always the most useful – it’s best at being popular.
Moreover, Retail Sales data is limited. With only 2 recessions (2001 and 2008), n=2 isn’t great for making predictions. We don’t know how Retail Sales performed in prior recessions, e.g. 1990, 1981-1982, 1980, 1973-1974, 1969-1970.
Best quarter for stocks and bonds
2018 was a rare year in which almost every major asset class fell. 2019 is another rare year in which almost every major asset class is going up.
Q1 2019 was a tremendous quarter for both the stock market and corporate bond market.
Here’s a chart that overlaps the S&P 500 against the investment grade corporate bond market (Bloomberg ticker symbol LUACTRUU)
Here’s what happens next to the S&P 500 when investment grade bonds and the S&P both rally 3 months in a row.
*Data from 1973 – present
As you can see, this is quite bullish for the stock market, especially 6-12 months later.
Commodities
- Stocks are rallying
- Bonds are rallying
- Commodities are also rallying
Bloomberg notes that this is commodities’ best quarter since 2016
Oil has rallied along with the S&P over the past 3 months.
This is a bullish sign for stocks 1 year later.
*Data from 1983 – present
This is neither consistently bullish nor bearish for oil itself.
Commodities’ price action
Before I focused on the S&P 500, I used to trade gold and silver. Our primary method for trading gold and silver was to read their price action (reading the tape). And it worked well. We averaged 44% a year from 2008-2017 in our family fund trading gold, silver, and gold miners.
With that being said, there is a bit of abnormal price action in the commodities markets right now. While oil rallied throughout February and March, gold and silver fell. This is “non-confirmation”.
(I’ve noticed over the years that “non-confirmation” and “divergences” are more useful in the commodity markets than stock markets).
Here’s what happens next to gold when oil rallies 2 consecutive months while precious metals fall 2 consecutive months.
Here’s what happens next to silver when oil rallies 2 consecutive months while precious metals fall 2 consecutive months.
Here’s what happens next to oil when oil rallies 2 consecutive months while precious metals fall 2 consecutive months.
It seems that everyone has their turn in the sun. Previously lagging precious metals outperform leading oil.
Read Market outlook: macro weakness is offset by bullish price action
Conclusion
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.
Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.
