It's been an epic 3 month turnaround for the stock market. What's next


It’s been 3 months since the stock market’s bottom on Christmas Eve 2018. The stock market has staged an epic turnaround while global economic growth (mostly foreign) slows down.

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.

Global trade slowdown

As you probably know, global economic growth is slowing down. This economic weakness is more pronounced outside of the U.S. than within the U.S.
The bears quickly jump on foreign weakness as a reason for why U.S. stocks will fall. How many times have you heard these words over the past 10 years?

  1. Emerging market / China weakness will lead to U.S. stock market crash!
  2. European problems will lead to contagion in the U.S.!
  3. Developing countries’ debt bubble will lead to an economic recession and bear market in the U.S.! When one domino falls, the other dominos fall!

These statements have been wrong for the most part despite the nonstop flow of problems from abroad. This is because the U.S. economy is a relatively isolated economy compared to other major economies such as China, Germany, Japan, etc. The U.S. economy relies less on import/exports than other economies simply because the U.S. is so big and diverse. Josh Brown echoed this today on CNBC, stating that the U.S. has never imported a recession from abroad. So think about this the next time media headlines scream CONTAGION FEARS.
Nevertheless, foreign and international economic data are still worth watching, even though they’re far less important to U.S. stock market investors than U.S. economic data.
Bloomberg reports that global trade growth has slowed down.

Is this a real problem, or is this another one of those “the last time this happened was [insert scary date], but the 40 other times before that were not bearish?” Here’s the complete data, from 2000 – present
This is the 3 month % change in the 3 month average of global trade growth.

This is the 1 year % change in the 3 month average of global trade growth.

As you can see, this is indeed somewhat of a worry. Here’s what happens next to the S&P when the 3 month % change in global trade’s 3 month average falls below -1%.

You can see that this exclusively happened in 2001, 2008, and 2015.
I would treat this as a warning sign rather than an outright bearish sign. You should generally be hesitant when using ex-U.S. economic data to predict the U.S. stock market.

S&P 500 Golden Cross

The S&P 500 will soon make a “golden cross”, whereby its 50 dma crosses above its 200 dma.

Traditional technical analysis sees a “golden cross” as bullish and a “death cross” as bearish.
*Death cross = 50 dma falls below 200 dma
However, using the strategy “buy on the golden cross, sell on the death cross” actually underperforms buy and hold

The only way to beat buy and hold using moving average crosses is if instead of selling the S&P when a death cross occurs, you buy bonds.
Here’s what happens when you buy the S&P when its 50 dma > 200 dma, and buy the Bloomberg Barclay’s U.S. Aggregate Bond Index when the S&P’s 50 dma < 200 dma.

60/40 balanced portfolio

A traditional 60/40 balanced portfolio (advocated by many financial advisors) puts 60% of its assets into stocks and 40% of its assets into bonds.

This has been one of the best quarters for the traditional 60/40 portfolio in years because both stocks and bonds have been rallying hard

  1. Stocks are rallying after crashing in Q4 2018
  2. Bonds are rallying because interest rates are falling. (bond prices move inversely with interest rates)


Here’s what happens next to the S&P when the 60/40 portfolio rises more than 9% over the past 3 months

This is more bullish than bearish for stocks over the next 6-12 months

Epic rate-of-change

It has been 3 months since the stock market’s bottom on Christmas Eve 2018. In an act of perfect symmetry, the S&P’s 3 month rate-of-change has gone from -19% to +19% over the past 3 months.
Over the past 30 years, this has only happened 1 other time: the 2009 bottom.

To avoid recency bias, let’s look at all the cases in which such a dramatic turnaround happened from 1923 – present

This is extremely rare and not consistently bearish or bullish.

Conference Board LEI

The latest reading for the Conference Board Leading Economic Index returned to its all-time high.

Here’s a thought experiment. Let’s look at what happens next to the S&P 500 when the Conference Board LEI peaks in each economic expansion.

The stock market’s forward returns are more bearish than random when this happens.
Of course, there’s no way to know without 20/20 hindsight whether the Conference Board LEI has peaked in this economic expansion or not. So this is not a bearish factor for the stock market right now.

USD Index

Last week the USD Index fell below its 200 dma for the first time in almost 11 months.

Here’s what happens next to the USD Index when it falls below its 200 dma for the first time in 9 months.

As you can see, the US Index’s 2-12 month forward returns are more bullish than random.
Is this a headwind for the S&P 500?

No.

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 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.
  2. 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.

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.
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