While the S&P 500 is just 1% below its all-time highs, the S&P 500 Total Return Index (including dividends) has now made an all-time high.
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.
Almost new highs
The S&P 500 is now within 1% of an all-time high (CLOSE $).
Here’s what happens next to the S&P when it is within -1% of 2 year highs, after being more than -19% below 2 year highs sometime within the past 6 months.
*Data from 1950 – present
It seems that such fast reversals are mostly bullish for the stock market 3-12 months later. What if we increase the sample size?
Here’s what happens next to the S&P when it is within -1% of 2 year highs, after being more than -15% below 2 year highs sometime within the past 6 months.
*Data from 1923 – present
The 3-12 month forward returns are still quite bullish. I generally don’t like to use pre-1950 S&P data because the S&P does not include dividends. Dividends were much higher pre-1950s than post-1950s.
Total returns new highs
While the S&P has almost made new highs, the S&P 500 Total Return Index has already made new highs. (Total Return includes dividends reinvested, since dividends account for a % of investors’ gains).
Here’s what happens next to the S&P when it makes a 1 year high, after being more than -15% below 1 year highs sometime within the past 6 months.
*Data from 1988 – present
Once again, mostly bullish for stocks 2-12 months later.
But what about VIX? Will volatility finally spike?
Not necessarily. Here’s what happens next to VIX when the S&P Total Return Index makes a 1 year high.
VIX fell below 12 today for the first time since October 2018 (daily LOW $).
Here’s what happens next to VIX when it falls below 12 for the first time in half a year.
*Data from 1990 – present.
Here’s what happens next to the S&P
Let’s expand the sample size. Here’s what happens next to VIX when it falls below 12 for the first time in 3 months.
You can see that VIX tends to rise in the short term. Does this mean that you should automatically go long VIX?
The problem with long VIX is that it’s hard to find a good trading vehicle for doing so. All the VIX ETFs have big ETF decay problems. So even if VIX “eventually” goes up, the decay may be so significant that you still lose money.
Anyways, here’s what happens next to the S&P
While the stock market has rallied significantly over the past 3.5 months, corporate bond spreads have not narrowed significantly. This is a necessary but not sufficient condition for bear markets. In the past, corporate bond spreads trended higher before bear markets and recessions began.
With that being said, the following is a popular bearish misconception:
This chart overlaps the S&P ontop of the BAA Corporate Bond spread (inverted). Notice how the S&P has “diverged” from the BAA Corporate Bond spread.
This divergence is not as long term bearish as you think it is. Here’s what happens next to the S&P when BAA Spreads narrow less than -10% over the past 75 days while the S&P rallies more than 20%.
I’m watching oil right now because it maintains a strong correlation with the S&P 500. WTI oil is up 6 weeks in a row.
Correlation is not causation, but the strength of this correlation is quite amazing.
Here’s what happens next to oil when it goes up 6 weeks in a row.
As you can see, oil has a bearish lean 1 month later.
Here’s what happens next to the S&P
11 out of 12
The S&P has gone up 11 of the past 12 days. Is this a short term bearish factor for the stock market?
No. Mostly random.
S&P vs. small caps
One of the things that continues to surprise me is how badly small caps are lagging the rest of the stock market right now.
While large caps and tech are either at or almost at all-time highs, the Russell 2000 (small caps index) is still more than -8% below its all-time high.
Experienced traders will recall that this is how the dot-com bubble played out.
How bearish is this for the stock market?
Here’s what happens next to the S&P when it is within -1% of a 1 year high, while the Russell is still more than -8% below its 1 year high.
You can see that aside from the dot-com bubble, this is not consistently bearish.
Here’s what happens next to the Russell 2000.
In just 2 months, this will officially be the longest economic expansion in U.S. history. A quick reminder: economic expansions don’t die of old age. In fact, economic expansions have lasted longer and longer after the Great Depression.
While some blame the economic expansion on the Fed (only in the finance industry will people hate economic expansions and bull markets), Bill McBride has a different explanation. Bill is one of the few must-follows on my list.
A key reason the current expansion has been so long is that housing didn’t contribute for the first few years of the expansion. Also the housing recovery was sluggish for a few more years after the bottom in 2011. This was because of the huge overhang of foreclosed properties coming on the market. Single family housing starts and new home sales both bottomed in 2011 – so this is just the eight year of housing expansion – and I expect further increases in starts and sales over the next year or longer.
Bill makes a good point. The recovery in housing (according to Housing Starts) only really began in 2011.
And lastly, a quick reminder about the importance of focus and tuning out the noise when investing/trading.
- Always think for yourself. Never turn bullish/bearish just because your favorite guru is bullish/bearish. Everyone can be wrong, no matter how stellar their past track record. And for the record, BullMarkets.co is not immune to errors either.
- Always do your own homework.
- Pay attention to the news, but not too much attention. Contrary to popular belief, most of the “experts” don’t know much more than you and I. Knowing how to say something that sounds “smart” is not the same as saying something that is actually smart.
Read Will the stock market become more volatile?
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. At the moment, the short term does seem to have a slight bearish lean.
- In summary, 12-24 months = bearish, 12 months = neutral, 6-9 months = slightly bullish.
Goldman Sachs’ Bull/Bear Indicator demonstrates that 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.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
Click here for more market analysis