The economy is getting worse. What this means for stocks
The U.S. economy is starting to deteriorate, which is what typically happens in the last year of a bull market.
Let’s determine the stock market’s most probable 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, week, or month.
*Probability ≠ certainty.
The economy is deteriorating
The economy and the stock market move in the same direction in the long term. Hence, leading economic indicators are also long term leading stock market indicators.
Leading indicators are starting to show some signs of deterioration, but not enough for the bull market to peak. The usual chain of events looks like this:
Housing – the earliest leading indicators – starts to deteriorate. Meanwhile, the U.S. stock market is still in a bull market while the rest of the U.S. economy improves. The rally gets choppy, with volatile corrections along the way. We are here right now
The labor market starts to deteriorate. Meanwhile, the U.S. stock market is still in a bull market. This will likely happen in the first half of 2019
The labor market deteriorates some more, while other economic indicators start to deteriorate. The stock market tops, and the bull market is over.
Let’s look at the data.
*Read today’s fundamental outlook. Fundamentals determine the stock market’s long term direction. Technicals determine the stock market’s medium term direction. As we approach the end of this bull market, fundamentals are more important than technicals. There is not a single technical indicator that can consistently predict bull market tops (without too many false signals). That’s why fundamentals are useful.
While this will be a long term bearish factor in 2019, I don’t think it’s a cause for concern right now.
In our free Golden/Death Cross Model with Initial Claims Filter, we want to see Initial Claims rise above its 1 year moving average for 8 consecutive weeks (i.e. a sustained rise in Initial Claims). So far, Initial Claims has been above its 1 year moving average for 2 consecutive weeks.
Here’s what happened next to the S&P when Initial Claims is above its 1 year average for 2 consecutive weeks while the S&P is below its 200 day moving average.
*Data from 1967 – present
While this is slightly short term bearish for the stock market, it isn’t medium term or long term bearish for stocks.
Wait for Initial Claims to rise a little more before turning long term bearish.
The Put/Call ratio’s 20 day moving average was very high at the end of October, which coincided with the stock market’s bottom.
With the stock market bouncing off its lows, the Put/Call ratio has returned to normal.
Here’s what happened next to the S&P when the Put/Call ratio’s 20 day moving average went above 1.1 and then fell below 1 within the past month
*Data from 1995 – present
As you can see, this isn’t consistently bullish or bearish for the stock market on any time frame.
Big 3 day gains
Jodie Gunzberg (S&P Dow Jones Indices managing director, head of U.S. equities) said:
Is Jodie correct?
Here’s what happened next to the S&P 500 when it gained more than 4.2% over the past 3 days, while within 10% of a 2 year high.
*Data from 1928 – present
As you can see, this isn’t extremely bullish for stocks. Jodie’s mistake is that she uses limited data: “past 5 years”. Investors and traders should always look at the data holistically instead of selectively.