January 3, 2019: fundamental outlook for stocks


*Go to the blog for my latest market outlook. Members can go here to see our trading model’s latest updates and how we’re trading the U.S. stock market right now based on these models.
The economy and stock market move in the same direction in the long term. Hence, leading economic indicators are also leading indicators for the stock market.

Thoughts

*We’re seeing mixed readings in the leading economic indicators right now. Some are still bullish while others are turning bearish. This is typically what happens towards the end of bull markets, when leading indicators start to deteriorate one at a time.

  1. Net earnings revisions is solidly negative. A long term bearish sign.
  2. Unit profits are down. Long term risk:reward is not bullish.
  3. The ISM New Orders Index fell. Not a bearish sign for the U.S. stock market.
  4. Initial Claims is trending sideways/upwards. Not long term bearish for U.S. stocks yet, but will be bearish in Q1 2019 if Initial Claims starts to trend upwards significantly.
  5. Continued Claims are trending sideways. Not long term bearish for U.S. stocks yet, but watch out if this starts to trend upwards.
  6. Important macro discretionary outlook

Read Safe havens are surging. What this means for stocks
Net earnings revisions just turned negative. A long term bearish sign.
As of November 2018, the S&P 500’s S&P 500’s net earnings revisions turned negative for the first time in almost 2 years. Its reading for December 2018 is now solidly negative.

The S&P 500’s Net Earnings Revisions turns negative before economic recessions and equity bear markets begin. During economic expansions, it has shown mixed performances because analysts tend to downgrade their earnings expectations as the year goes on. That’s why negative Net Earnings Revisions is a necessary but not sufficient requirement for equities bear markets and economic recessions.
This “necessary but not sufficient requirement for bear markets” is now a long term bearish sign.
Unit profits are down. Long term risk:reward is not bullish.
Corporate unit profits have been trending downwards since the end of 2014.
This IS NOT a timing indicator for predicting the end of bull markets. Sometimes unit profits will fall a year or two before recessions and bear markets begin. Sometimes unit profits will fall for half a decade before bear markets begin. But this does tell us that 2014/2015 marked the halfway point for this economic expansion and bull market.

This indicator suggests that even if the S&P goes on to make new all-time highs after the recent -20% decline, the equities bull market doesn’t have many years left.
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This chart demonstrates the relationship between Unit Profits and the S&P 500
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The ISM New Orders Index fell. Not a bearish sign for the U.S. stock market.
In the financial markets, knowing what NOT to look at is just as important as knowing what to look at. Making the right investment for the wrong reason = betting on luck.
The ISM New Orders Index tanked today and is now almost at 50 (below 50 = contraction level).

While this certainly isn’t bullish for stocks, it’s not bearish either. The ISM New Orders Index has predicted 50 of the last 4 recessions and bear markets. There are far too many false alarms for this indicator to be useful.
Initial Claims is trending sideways/upwards. Not long term bearish for U.S. stocks yet, but will be bearish in Q1 2019 if Initial Claims starts to trend upwards significantly.
Yesterday’s reading for Initial Claims went up from its previous reading (from 221k to 231k). While Initial Claims have mostly been trending lower throughout 2018, they are trending sideways now. Perhaps Initial Claims will start to significantly trend upwards in Q1 2019.

*Initial Claims leads the economy and stock market. Historically, it trends higher before a bear market in stocks started (see study).

We are watching out for any SUSTAINED increase in this data series because Initial Claims are very low right now (historically speaking).
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This chart demonstrates the relationship between Initial Claims & the S&P 500
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Continued Claims are trending sideways. Not long term bearish for U.S. stocks yet, but watch out if this starts to trend upwards.
Yesterday’s reading for Continued Claims went up (from 1.708 million to 1.740 million). However, the key point is that Continued Claims are trending sideways.

Like Initial Claims, Continued Claims lead the stock market and economy.

We are watching out for any SUSTAINED increase in this data series because Continued Claims are very low right now (historically speaking).
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This chart demonstrates the relationship between Initial Claims & the S&P 500
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Important macro discretionary outlook
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*This is for members-only
Leading economic indicators in Q1 2019 will probably deteriorate.

  1. The housing sector will probably be down slightly in 2019. Talking to some real estate agents, they say that while real estate tanked in the second half of 2018, it looks like the first 3 months of 2019 will see the real estate market muddle through (neither good nor bad).
  2. The labor market will probably deteriorate a little due to the prolonged government shutdown. Initial Claims tends to spike during a government shutdown.

It’s interesting how Ed Yardeni has come to this same conclusion.

In this video, I discuss why the new year is likely to start with some downbeat economic data that should cause the Fed to pause hiking interest rates. Regional business surveys conducted by five of the Fed district banks were very weak during December. That explains the recent drop in the 10-year Treasury bond yield below 2.70%.

Remember how I said in the weekend market outlook that the S&P will face a fork in the road in 2019?

If macro data does deteriorate in Q1-Q2 2019, then the downwards fork in the road is more likely.
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Read Stocks on December 27, 2018: outlook

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
  3. The stock market’s short term has a slight bearish lean. Focus on the medium-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 is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading models, such as the Medium-Long Term Model.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
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